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Is Petrofac Limited's (LON:PFC) 7.4% Dividend Worth Your Time?

Simply Wall St

Could Petrofac Limited (LON:PFC) 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, Petrofac likely looks attractive to investors, given its 7.4% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. The company also returned around 2.3% of its market capitalisation to shareholders in the form of stock buybacks over the past year. There are a few simple ways to reduce the risks of buying Petrofac for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Petrofac!

LSE:PFC Historical Dividend Yield, December 5th 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. In the last year, Petrofac paid out 58% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Petrofac's cash payout ratio last year was 18%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Petrofac's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

With a strong net cash balance, Petrofac investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Petrofac'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. For the purpose of this article, we only scrutinise the last decade of Petrofac's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.25 in 2009, compared to US$0.38 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.1% a year over that time. Petrofac's dividend payments have fluctuated, so it hasn't grown 4.1% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Over the past five years, it looks as though Petrofac's EPS have declined at around 19% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

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. Petrofac's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Earnings per share are down, and Petrofac's dividend has been cut at least once in the past, which is disappointing. In sum, we find it hard to get excited about Petrofac 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.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.