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What To Know Before Buying NorthWestern Corporation (NYSE:NWE) For Its Dividend

Simply Wall St

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Could NorthWestern Corporation (NYSE:NWE) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, NorthWestern likely looks attractive to investors, given its 3.2% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

NYSE:NWE Historical Dividend Yield, July 3rd 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 53% of NorthWestern's profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. NorthWestern paid out 486% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. While NorthWestern's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were NorthWestern to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is NorthWestern's Balance Sheet Risky?

As NorthWestern has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 4.61 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 3.00 times its interest expense is starting to become a concern for NorthWestern, and be aware that lenders may place additional restrictions on the company as well.

We update our data on NorthWestern every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of NorthWestern's dividend payments. During the past ten-year period, the first annual payment was US$1.32 in 2009, compared to US$2.30 last year. Dividends per share have grown at approximately 5.7% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see NorthWestern has grown its earnings per share at 11% per annum over the past five years. NorthWestern's earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.

We'd also point out that NorthWestern issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that NorthWestern's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. NorthWestern gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Next, growing earnings per share and steady dividend payments is a great combination. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than NorthWestern out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 3 analysts we track are forecasting for NorthWestern for free with public analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.