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Is Sonic Healthcare Limited (ASX:SHL) An Attractive Dividend Stock?

Simply Wall St

Today we'll take a closer look at Sonic Healthcare Limited (ASX:SHL) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

A 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Sonic Healthcare has some staying power. Some simple analysis can reduce the risk of holding Sonic Healthcare for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Sonic Healthcare!

ASX:SHL Historical Dividend Yield, November 12th 2019

Payout ratios

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. 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, Sonic Healthcare paid out 69% 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 79% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's positive to see that Sonic Healthcare'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 Sonic Healthcare's Balance Sheet Risky?

As Sonic Healthcare 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. Sonic Healthcare has net debt of 2.35 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Sonic Healthcare has EBIT of 8.90 times its interest expense, which we think is adequate.

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

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. For the purpose of this article, we only scrutinise the last decade of Sonic Healthcare's dividend 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 AU$0.54 in 2009, compared to AU$0.84 last year. Dividends per share have grown at approximately 4.5% 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

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Sonic Healthcare has grown its earnings per share at 4.9% per annum over the past five years. Growth of 4.9% is relatively anaemic growth, which we wonder about. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.

We'd also point out that Sonic Healthcare 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

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 think Sonic Healthcare is paying out an acceptable percentage of its cashflow and profit. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Sonic Healthcare out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 10 Sonic Healthcare analysts we track are forecasting continued growth with our free report on analyst estimates 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 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.