Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Canadian Utilities Limited (TSE:CU) is about to trade ex-dividend in the next 4 days. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the dividend. The ex-dividend date is important as the process of settlement involves two full business days. So if you miss that date, you would not show up on the company's books on the record date. Accordingly, Canadian Utilities investors that purchase the stock on or after the 8th of August will not receive the dividend, which will be paid on the 1st of September.
The company's next dividend payment will be CA$0.4531 per share. Last year, in total, the company distributed CA$1.81 to shareholders. Last year's total dividend payments show that Canadian Utilities has a trailing yield of 5.5% on the current share price of CA$32.95. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Canadian Utilities can afford its dividend, and if the dividend could grow.
If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Its dividend payout ratio is 84% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. We'd be worried about the risk of a drop in earnings. A useful secondary check can be to evaluate whether Canadian Utilities generated enough free cash flow to afford its dividend. Over the past year it paid out 137% of its free cash flow as dividends, which is uncomfortably high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.
While Canadian Utilities's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were this to happen repeatedly, this would be a risk to Canadian Utilities's ability to maintain its dividend.
Companies that aren't growing their earnings can still be valuable, but it is even more important to assess the sustainability of the dividend if it looks like the company will struggle to grow. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're not enthused to see that Canadian Utilities's earnings per share have remained effectively flat over the past five years. Better than seeing them fall off a cliff, for sure, but the best dividend stocks grow their earnings meaningfully over the long run. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Canadian Utilities has delivered 6.5% dividend growth per year on average over the past 10 years.
To Sum It Up
Should investors buy Canadian Utilities for the upcoming dividend? Canadian Utilities is paying out a reasonable percentage of its income yet an uncomfortably high 137% of its cash flow as dividends. What's more, earnings have barely grown. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
