Today we'll take a closer look at Finning International Inc. (TSE:FTT) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
With Finning International yielding 3.5% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock during the year, equivalent to approximately 3.6% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
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 be form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 71% of Finning International'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. Unfortunately, while Finning International 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. It's positive to see that Finning International'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.
Is Finning International's Balance Sheet Risky?
As Finning International 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. With net debt of above 3x EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Finning International has EBIT of 5.65 times its interest expense, which we think is adequate.
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 Finning International's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was CA$0.44 in 2009, compared to CA$0.82 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.4% a year over that time.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Over the past five years, it looks as though Finning International's EPS have declined at around 10% a year. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
To summarise, shareholders should always check that Finning International's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Finning International has an acceptable payout ratio, although its dividend was not well covered by cashflow. Moreover, earnings have been shrinking. While the dividends have been fairly steady, we'd wonder for how much longer this will be sustainable if earnings continue to decline. With this information in mind, we think Finning International may not be an ideal dividend stock.
Given that earnings are not growing, the dividend does not look nearly so attractive. 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%.
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 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. Thank you for reading.