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It looks like Kennametal Inc. (NYSE:KMT) is about to go ex-dividend in the next 2 days. Ex-dividend means that investors that purchase the stock on or after the 11th of May will not receive this dividend, which will be paid on the 27th of May.
Kennametal's next dividend payment will be US$0.20 per share. Last year, in total, the company distributed US$0.80 to shareholders. Looking at the last 12 months of distributions, Kennametal has a trailing yield of approximately 3.5% on its current stock price of $22.95. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to check whether the dividend payments are covered, and if earnings are growing.
If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Last year, Kennametal paid out 101% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. Over the last year, it paid out dividends equivalent to 398% of what it generated in free cash flow, a disturbingly high percentage. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.
Cash is slightly more important than profit from a dividend perspective, but given Kennametal's payouts were not well covered by either earnings or cash flow, we would be concerned about the sustainability of this dividend.
Have Earnings And Dividends Been Growing?
Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. With that in mind, we're discomforted by Kennametal's 17% per annum decline in earnings in the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.
Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Kennametal has delivered an average of 5.2% per year annual increase in its dividend, based on the past ten years of dividend payments. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Kennametal is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.
Is Kennametal an attractive dividend stock, or better left on the shelf? It's looking like an unattractive opportunity, with its earnings per share declining, while, paying out an uncomfortably high percentage of both its profits (101%) and cash flow as dividends. This is a clearly suboptimal combination that usually suggests the dividend is at risk of being cut. If not now, then perhaps in the future. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.
With that in mind though, if the poor dividend characteristics of Kennametal don't faze you, it's worth being mindful of the risks involved with this business. To help with this, we've discovered 5 warning signs for Kennametal that you should be aware of before investing in their shares.
If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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