Today we'll take a closer look at TORM plc (CPH:TRMD A) 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.
Investors might not know much about TORM's dividend prospects, even though it has been paying dividends for the last four years and offers a 1.4% yield. 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. Remember that the recent share price drop will make TORM's yield look higher, even though recent events might have impacted the company's prospects. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
CPSE:TRMD A Historical Dividend Yield April 4th 2020
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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. TORM paid out 4.5% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
Is TORM's Balance Sheet Risky?
As TORM has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 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. TORM is carrying net debt of 3.96 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.48 times its interest expense is starting to become a concern for TORM, and be aware that lenders may place additional restrictions on the company as well.
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 TORM has been paying a dividend for the past four years. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past four-year period, the first annual payment was US$0.80 in 2016, compared to US$0.10 last year. This works out to a decline of approximately 88% over that time.
We struggle to make a case for buying TORM for its dividend, given that payments have shrunk over the past four 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. It's good to see TORM has been growing its earnings per share at 41% a year over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.
Conclusion
To summarise, shareholders should always check that TORM's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that TORM has a low and conservative payout ratio. 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. TORM fits all of our criteria, and we think there are a lot of positives to it from a dividend perspective.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Just as an example, we've come accross 4 warning signs for TORM you should be aware of, and 3 of them are concerning.
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.
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. Thank you for reading.
