Dividend paying stocks like Recipe Unlimited Corporation (TSE:RECP) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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 a 2.4% yield and a five-year payment history, investors probably think Recipe Unlimited 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 16% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding Recipe Unlimited for its dividend, and we'll focus on the most important aspects below.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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. In the last year, Recipe Unlimited paid out 50% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase the payout ratio over time.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Recipe Unlimited's cash payout ratio last year was 16%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Recipe Unlimited'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 Recipe Unlimited's Balance Sheet Risky?
As Recipe Unlimited 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 2.61 times its EBITDA, Recipe Unlimited's debt burden is within a normal range for most listed companies.
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 7.37 times its interest expense appears reasonable for Recipe Unlimited, although we're conscious that even high interest cover doesn't make a company bulletproof.
Remember, you can always get a snapshot of Recipe Unlimited's latest financial position, by checking our visualisation of its financial health.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Looking at the data, we can see that Recipe Unlimited has been paying a dividend for the past five years. During the past five-year period, the first annual payment was CA$0.37 in 2015, compared to CA$0.45 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.1% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Recipe Unlimited'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. Recipe Unlimited is paying out less than half of its earnings, which we like. 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.
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. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. Overall we think Recipe Unlimited is an interesting dividend stock, although it could be better.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 3 analysts we track are forecasting for Recipe Unlimited 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%.
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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