Today we'll take a closer look at EnBW Energie Baden-Württemberg AG (ETR:EBK) 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. 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.
While EnBW Energie Baden-Württemberg's 1.4% dividend yield is not the highest, we think its lengthy payment history is quite interesting. There are a few simple ways to reduce the risks of buying EnBW Energie Baden-Württemberg for its dividend, and we'll go through these below.
XTRA:EBK Historical Dividend Yield, February 13th 2020
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 114% of EnBW Energie Baden-Württemberg's profits were paid out as dividends in the last 12 months. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while EnBW Energie Baden-Württemberg pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is EnBW Energie Baden-Württemberg's Balance Sheet Risky?
As EnBW Energie Baden-Württemberg'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. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 3.45 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.
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 7.25 times its interest expense appears reasonable for EnBW Energie Baden-Württemberg, although we're conscious that even high interest cover doesn't make a company bulletproof.
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. For the purpose of this article, we only scrutinise the last decade of EnBW Energie Baden-Württemberg's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was €2.01 in 2010, compared to €0.65 last year. The dividend has fallen 68% over that period.
We struggle to make a case for buying EnBW Energie Baden-Württemberg for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see EnBW Energie Baden-Württemberg has grown its earnings per share at 25% per annum over the past five years. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet.
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. We're a bit uncomfortable with EnBW Energie Baden-Württemberg paying out a high percentage of both its cashflow and earnings. 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, EnBW Energie Baden-Württemberg has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.
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.
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