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Should RGC Resources, Inc. (NASDAQ:RGCO) Be Part Of Your Dividend Portfolio?

Simply Wall St

Today we'll take a closer look at RGC Resources, Inc. (NASDAQ:RGCO) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A 2.3% yield is nothing to get excited about, but investors probably think the long payment history suggests RGC Resources has some staying power. Some simple research can reduce the risk of buying RGC Resources for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on RGC Resources!

NasdaqGM:RGCO Historical Dividend Yield, October 8th 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. RGC Resources paid out 58% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, RGC Resources paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is RGC Resources's Balance Sheet Risky?

As RGC Resources 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. RGC Resources is carrying net debt of 4.61 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 3.63 times its interest expense is starting to become a concern for RGC Resources, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on RGC Resources's financial position here.

Dividend Volatility

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. RGC Resources has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$0.42 in 2009, compared to US$0.66 last year. Dividends per share have grown at approximately 4.7% per year over this time.

While the consistency in the dividend payments is impressive, we think the relatively slow rate of growth is unappealing.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see RGC Resources has grown its earnings per share at 13% per annum over the past five years. Earnings per share have been growing rapidly, but given that it is paying out more than half of its earnings as dividends, we wonder how RGC Resources will keep funding its growth projects in the future.

We'd also point out that RGC Resources issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that RGC Resources'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 RGC Resources has an acceptable payout ratio, although its dividend was not well covered by cashflow. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. In sum, we find it hard to get excited about RGC Resources 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.

See if management have their own wealth at stake, by checking insider shareholdings in RGC Resources stock.

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.