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Should Orion Engineered Carbons S.A. (NYSE:OEC) Be Part Of Your Dividend Portfolio?

Simply Wall St

Could Orion Engineered Carbons S.A. (NYSE:OEC) 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 the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With a five-year payment history and a 6.4% yield, many investors probably find Orion Engineered Carbons intriguing. We'd agree the yield does look enticing. The company also bought back stock equivalent to around 1.5% of market capitalisation this year. Remember that the recent share price drop will make Orion Engineered Carbons's yield look higher, even though recent events might have impacted the company's prospects. Some simple research can reduce the risk of buying Orion Engineered Carbons for its dividend - read on to learn more.

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NYSE:OEC Historical Dividend Yield, August 16th 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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 56% of Orion Engineered Carbons'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. With a cash payout ratio of 119%, Orion Engineered Carbons's dividend payments are poorly covered by cash flow. Orion Engineered Carbons paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Orion Engineered Carbons to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is Orion Engineered Carbons's Balance Sheet Risky?

As Orion Engineered Carbons 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 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 2.54 times its EBITDA, Orion Engineered Carbons has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 7.98 times its interest expense appears reasonable for Orion Engineered Carbons, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Orion Engineered Carbons's financial position 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. Orion Engineered Carbons has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.83 in 2014, compared to US$0.80 last year. The dividend has shrunk at a rate of less than 1% a year over this period.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

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 Orion Engineered Carbons has grown its earnings per share at 56% per annum over the past five years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that Orion Engineered Carbons's growth will be slower in the future.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Orion Engineered Carbons 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. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. In sum, we find it hard to get excited about Orion Engineered Carbons 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.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for Orion Engineered Carbons 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.