Dividend paying stocks like Luzhou Xinglu Water (Group) Co., Ltd. (HKG:2281) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested 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.
Luzhou Xinglu Water (Group) pays a 5.3% dividend yield, and has been paying dividends for the past two years. A 5.3% yield does look good. Could the short payment history hint at future dividend growth? When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
SEHK:2281 Historical Dividend Yield April 29th 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Luzhou Xinglu Water (Group) paid out 27% of its profit as dividends, over the trailing twelve month period. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Luzhou Xinglu Water (Group) paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Luzhou Xinglu Water (Group)'s Balance Sheet Risky?
As Luzhou Xinglu Water (Group) has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 2.88 times its EBITDA, Luzhou Xinglu Water (Group)'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. With EBIT of 46.79 times its interest expense, Luzhou Xinglu Water (Group)'s interest cover is quite strong - more than enough to cover the interest expense.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past two-year period, the first annual payment was CN¥0.08 in 2018, compared to CN¥0.06 last year. This works out to a decline of approximately 25% over that time.
A shrinking dividend over a two-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.
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 not great to see that Luzhou Xinglu Water (Group)'s have fallen at approximately 2.4% over the past five years. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.
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. First, we like Luzhou Xinglu Water (Group)'s low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. With this information in mind, we think Luzhou Xinglu Water (Group) may not be an ideal dividend stock.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we've identified 2 warning signs for Luzhou Xinglu Water (Group) (1 is a bit concerning!) that you should be aware of before investing.
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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