Know This Before Buying Peet Limited (ASX:PPC) For Its Dividend

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Could Peet Limited (ASX:PPC) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

In this case, Peet likely looks attractive to investors, given its 3.8% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. The company also returned around 1.1% of its market capitalisation to shareholders in the form of stock buybacks over the past year. 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 Peet!

ASX:PPC Historical Dividend Yield, January 20th 2020
ASX:PPC Historical Dividend Yield, January 20th 2020

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Peet paid out 51% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Peet paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Peet's Balance Sheet Risky?

As Peet 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. Peet has net debt of 3.67 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Peet has EBIT of 6.86 times its interest expense, which we think is adequate.