Today we'll take a closer look at Kansas City Southern (NYSE:KSU) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
With a 1.2% yield and a seven-year payment history, investors probably think Kansas City Southern 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 2.0% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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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. Kansas City Southern paid out 25% of its profit as dividends, over the trailing twelve month period. We'd say its dividends are thoroughly covered by earnings.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Kansas City Southern's cash payout ratio in the last year was 37%, which suggests dividends were well covered by cash generated by the business.
Is Kansas City Southern's Balance Sheet Risky?
As Kansas City Southern has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). Kansas City Southern has net debt of 2.07 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 8.67 times its interest expense appears reasonable for Kansas City Southern, although we're conscious that even high interest cover doesn't make a company bulletproof.
We update our data on Kansas City Southern every 24 hours, so you can always get our latest analysis of its financial health, here.
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. Looking at the data, we can see that Kansas City Southern has been paying a dividend for the past seven years. The dividend has been quite stable over the past seven years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past seven-year period, the first annual payment was US$0.78 in 2012, compared to US$1.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.2% a year over that time.
The dividend has been growing at a reasonable rate, which we like. We're conscious though that one of the best ways to detect a multi-decade consistent dividend payer, is to watch a company pay dividends for 20 years - a distinction Kansas City Southern has not achieved yet.
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. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see Kansas City Southern has been growing its earnings per share at 13% a year over the past 5 years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.
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. Firstly, we like that Kansas City Southern has low and conservative payout ratios. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. All things considered, Kansas City Southern looks like a strong prospect. At the right valuation, it could be something special.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 17 Kansas City Southern 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 firstname.lastname@example.org. 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.