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Would Masterflex SE (ETR:MZX) Be Valuable To Income Investors?

Simply Wall St

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Is Masterflex SE (ETR:MZX) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

With only a two-year payment history, and a 1.2% yield, investors probably think Masterflex is not much of a dividend stock. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. There are a few simple ways to reduce the risks of buying Masterflex for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

XTRA:MZX Historical Dividend Yield, June 17th 2019

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Masterflex paid out 20% of its profit as dividends. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while Masterflex pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Masterflex's Balance Sheet Risky?

As Masterflex has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). Masterflex has net debt of 2.49 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 5.12 times its interest expense appears reasonable for Masterflex, although we're conscious that even high interest cover doesn't make a company bulletproof.

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

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was €0.05 in 2017, compared to €0.07 last year. Dividends per share have grown at approximately 18% per year over this time.

Masterflex has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether 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. Earnings have grown at around 3.6% a year for the past five years, which is better than seeing them shrink! Growth has been hard to come by. On the plus side, the dividend payout ratio is low and dividends could grow faster than earnings, if the company decides to increase its payout ratio.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like Masterflex's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. In sum, we find it hard to get excited about Masterflex from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Now, if you want to look closer, it would be worth checking out our free research on Masterflex management tenure, salary, and performance.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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.