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Is The Unite Group plc (LON:UTG) A Strong Dividend Stock?

Simply Wall St

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Is The Unite Group plc (LON:UTG) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

A 3.0% yield is nothing to get excited about, but investors probably think the long payment history suggests Unite Group has some staying power. Some simple research can reduce the risk of buying Unite Group for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

LSE:UTG Historical Dividend Yield, June 26th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Unite Group paid out 104% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unite Group paid out 120% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given Unite Group's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Is Unite Group's Balance Sheet Risky?

As Unite Group's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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. Unite Group has net debt of more than 3x 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. Net interest cover of 7.89 times its interest expense appears reasonable for Unite Group, although we're conscious that even high interest cover doesn't make a company bulletproof.

We update our data on Unite Group every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Unite Group's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was UK£0.025 in 2009, compared to UK£0.29 last year. This works out to be a compound annual growth rate (CAGR) of approximately 28% a year over that time. Unite Group's dividend payments have fluctuated, so it hasn't grown 28% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Unite Group has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in 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 Unite Group has grown its earnings per share at 15% per annum over the past five years. While EPS are growing rapidly, Unite Group paid out a very high 104% of its income as dividends. If earnings continue to grow, this dividend may be sustainable, but we think a payout this high definitely bears watching.

We'd also point out that Unite Group 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. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In summary, Unite Group has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Now, if you want to look closer, it would be worth checking out our free research on Unite Group management tenure, salary, and performance.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.