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Is Spirit Realty Capital, Inc. (NYSE:SRC) A Great Dividend Stock?

Simply Wall St

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Could Spirit Realty Capital, Inc. (NYSE:SRC) 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. 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.

With a six-year payment history and a 5.6% yield, many investors probably find Spirit Realty Capital intriguing. We'd agree the yield does look enticing. The company also bought back stock during the year, equivalent to approximately 0.8% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Spirit Realty Capital for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

NYSE:SRC Historical Dividend Yield, July 5th 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Spirit Realty Capital paid out 93% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

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 87% 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 Spirit Realty Capital'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 Spirit Realty Capital's Balance Sheet Risky?

As Spirit Realty Capital 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 6.34 times its EBITDA, Spirit Realty Capital could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.

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 1.96 times its interest expense is starting to become a concern for Spirit Realty Capital, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

Consider getting our latest analysis on Spirit Realty Capital's financial position here.

Dividend Volatility

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. Spirit Realty Capital has been paying a dividend for the past six years. During the past six-year period, the first annual payment was US$3.28 in 2013, compared to US$2.50 last year. The dividend has shrunk at around 4.4% a year during that period.

We struggle to make a case for buying Spirit Realty Capital for its dividend, given that payments have shrunk over the past six years.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Spirit Realty Capital has grown its earnings per share at 42% per annum over the past five years. The company pays out most of its earnings as dividends, although with such rapid EPS growth, its possible the dividend is better covered than it looks. Still, we'd be cautious about extrapolating high growth too far out into the future.

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. Spirit Realty Capital's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Spirit Realty Capital out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 5 Spirit Realty Capital 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.