Today we'll take a closer look at DFS Furniture plc (LON:DFS) 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.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if DFS Furniture is a new dividend aristocrat in the making. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding DFS Furniture for its dividend, and we'll focus on the most important aspects below.
LSE:DFS Historical Dividend Yield, September 28th 2019
Payout ratios
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. 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. In the last year, DFS Furniture paid out 131% of its profit as dividends. 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. With a cash payout ratio of 131%, DFS Furniture's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given DFS Furniture's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.
Is DFS Furniture's Balance Sheet Risky?
As DFS Furniture's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 2.17 times its EBITDA, DFS Furniture's debt burden is within a normal range for most listed companies.
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 5.20 times its interest expense appears reasonable for DFS Furniture, 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. DFS Furniture has been paying a dividend for the past five years. During the past five-year period, the first annual payment was UK£0.062 in 2014, compared to UK£0.11 last year. Dividends per share have grown at approximately 13% per year over this time.
DFS Furniture has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see DFS Furniture has grown its earnings per share at 35% 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. DFS Furniture paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. With this information in mind, we think DFS Furniture may not be an ideal dividend stock.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 DFS Furniture analysts we track are forecasting continued growth with our freereport on analyst estimates for the company.
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.
