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Three Things You Should Check Before Buying CMS Energy Corporation (NYSE:CMS) For Its Dividend

Simply Wall St

Could CMS Energy Corporation (NYSE:CMS) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

While CMS Energy's 2.7% dividend yield is not the highest, we think its lengthy payment history is quite interesting. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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NYSE:CMS Historical Dividend Yield, May 16th 2019

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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 be form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, CMS Energy paid out 65% 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while CMS Energy 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.


Is CMS Energy's Balance Sheet Risky?

As CMS Energy 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. CMS Energy has net debt of 5.78 times its earnings before interest, tax, depreciation and amortisation (EBITDA) which implies meaningful risk if interest rates rise of earnings decline.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 2.72 times its interest expense, CMS Energy's interest cover is starting to look a bit thin. 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 CMS Energy'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. For the purpose of this article, we only scrutinise the last decade of CMS Energy'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 US$0.50 in 2009, compared to US$1.53 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time.


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. Earnings have grown at around 5.4% a year for the past five years, which is better than seeing them shrink! The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.

Conclusion

To summarise, shareholders should always check that CMS Energy'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 CMS Energy has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. In sum, we find it hard to get excited about CMS Energy 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.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 13 CMS Energy 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.