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Three Things You Should Check Before Buying Frontera Energy Corporation (TSE:FEC) For Its Dividend

Simply Wall St

Dividend paying stocks like Frontera Energy Corporation (TSE:FEC) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

Frontera Energy has only been paying a dividend for a year or so, so investors might be curious about its 8.4% yield. The company also bought back stock during the year, equivalent to approximately 3.2% of the company's market capitalisation at the time. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Explore this interactive chart for our latest analysis on Frontera Energy!

TSX:FEC Historical Dividend Yield, December 30th 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, Frontera Energy paid out 61% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift 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. Last year, Frontera Energy paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Frontera Energy's Balance Sheet Risky?

As Frontera Energy has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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 0.03 times its EBITDA, Frontera Energy has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 2.91 times its interest expense, Frontera Energy's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Frontera Energy'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. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. Dividends per share have grown at approximately 154% per year over this time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's good to see Frontera Energy has been growing its earnings per share at 11% a year 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 Frontera Energy will keep funding its growth projects in 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. Frontera Energy gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Frontera Energy out there.

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

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 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.

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. Thank you for reading.