Three Things You Should Check Before Buying KAR Auction Services, Inc. (NYSE:KAR) For Its Dividend
Could KAR Auction Services, Inc. (NYSE:KAR) 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 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.
With a 2.9% yield and a seven-year payment history, investors probably think KAR Auction Services looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock during the year, equivalent to approximately 2.8% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying KAR Auction Services for its dividend, and we'll go through these below.
Click the interactive chart for our full dividend analysis
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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 63% of KAR Auction Services's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. KAR Auction Services's cash payout ratio in the last year was 50%, which suggests dividends were well covered by cash generated by the business. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.
Is KAR Auction Services's Balance Sheet Risky?
As KAR Auction Services 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 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. KAR Auction Services has net debt of 3.01 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
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 2.87 times its interest expense is starting to become a concern for KAR Auction Services, and be aware that lenders may place additional restrictions on the company as well.
Remember, you can always get a snapshot of KAR Auction Services'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. KAR Auction Services has been paying a dividend for the past seven years. It's good to see that KAR Auction Services has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. Its most recent annual dividend was US$0.76 per share, effectively flat on its first payment seven years ago.
It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see KAR Auction Services has grown its earnings per share at 35% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 63%, this business looks like an interesting prospect if earnings are reinvested effectively.
Conclusion
To summarise, shareholders should always check that KAR Auction Services'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 KAR Auction Services has an acceptable payout ratio and its dividend is well covered by cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. KAR Auction Services has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 13 KAR Auction Services 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.
