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Read This Before Buying Arcos Dorados Holdings Inc. (NYSE:ARCO) For Its Dividend

Simply Wall St

Could Arcos Dorados Holdings Inc. (NYSE:ARCO) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With a 1.4% yield and a nine-year payment history, investors probably think Arcos Dorados Holdings looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also returned around 2.5% 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 Arcos Dorados Holdings for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Arcos Dorados Holdings!

NYSE:ARCO Historical Dividend Yield, October 23rd 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Arcos Dorados Holdings paid out 39% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

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 Arcos Dorados Holdings 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 Arcos Dorados Holdings's Balance Sheet Risky?

As Arcos Dorados Holdings 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 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 1.86 times its EBITDA, Arcos Dorados Holdings has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 3.11 times its interest expense is starting to become a concern for Arcos Dorados Holdings, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of Arcos Dorados Holdings's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The first recorded dividend for Arcos Dorados Holdings, in the last decade, was nine years ago. It's good to see that Arcos Dorados Holdings has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was US$0.24 in 2010, compared to US$0.11 last year. The dividend has shrunk at around 8.3% a year during that period. Arcos Dorados Holdings's dividend hasn't shrunk linearly at 8.3% per annum, but the CAGR is a useful estimate of the historical rate of change.

A shrinking dividend over a nine-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Arcos Dorados Holdings's EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

Conclusion

To summarise, shareholders should always check that Arcos Dorados Holdings's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. Ultimately, Arcos Dorados Holdings comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 Arcos Dorados Holdings analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.