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Today we'll take a closer look at MGE Energy, Inc. (NASDAQ:MGEE) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.
A 1.8% yield is nothing to get excited about, but investors probably think the long payment history suggests MGE Energy has some staying power. There are a few simple ways to reduce the risks of buying MGE Energy for its dividend, and we'll go through these below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. MGE Energy paid out 52% of its profit as dividends, over the trailing twelve month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Unfortunately, while MGE Energy 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.
Is MGE Energy's Balance Sheet Risky?
As MGE Energy 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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 2.40 times its EBITDA, MGE Energy's debt burden is within a normal range for most listed companies.
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 6.23 times its interest expense appears reasonable for MGE Energy, although we're conscious that even high interest cover doesn't make a company bulletproof.
We update our data on MGE Energy every 24 hours, so you can always get our latest analysis of its financial health, here.
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. MGE Energy has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During the past ten-year period, the first annual payment was US$0.95 in 2009, compared to US$1.35 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.6% a year over that time.
Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Earnings have grown at around 3.3% a year for the past five years, which is better than seeing them shrink! Growth of 3.3% is relatively anaemic growth, which we wonder about. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.
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 think MGE Energy has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than MGE Energy out there.
See if management have their own wealth at stake, by checking insider shareholdings in MGE Energy stock.
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 firstname.lastname@example.org. 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.