Is Air New Zealand Limited (NZSE:AIR) A Smart Pick For Income Investors?

Simply Wall St

Thu, Jun 27, 2019, 9:08 PM

Could Air New Zealand Limited (NZSE:AIR) 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. 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 Air New Zealand yielding 8.2% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on Air New Zealand!

NZSE:AIR Historical Dividend Yield, June 28th 2019

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 80% of Air New Zealand's profits were paid out as dividends in the last 12 months. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. With a cash payout ratio of 109%, Air New Zealand's dividend payments are poorly covered by cash flow. While Air New Zealand's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Air New Zealand's ability to maintain its dividend.

Consider getting our latest analysis on Air New Zealand's financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Air New Zealand's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was NZ$0.085 in 2009, compared to NZ$0.22 last year. This works out to be a compound annual growth rate (CAGR) of approximately 10.0% a year over that time. The dividends haven't grown at precisely 10.0% every year, but this is a useful way to average out the historical rate of growth.

A reasonable rate of dividend growth is good to see, but we're wary that the dividend history is not as solid as we'd like, having been cut at least once.

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. It's good to see Air New Zealand has been growing its earnings per share at 11% a year over the past 5 years. Earnings per share are growing nicely, but the company is paying out most of its earnings as dividends. This might be sustainable, but we wonder why Air New Zealand is not retaining those earnings to reinvest in growth.

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. Air New Zealand 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. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Air New Zealand out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 7 analysts we track are forecasting for Air New Zealand for free with public 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.

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