Today we'll take a closer look at Strides Pharma Science Limited (NSE:STAR) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
A slim 0.8% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Strides Pharma Science could have potential. Some simple analysis can reduce the risk of holding Strides Pharma Science for its dividend, and we'll focus on the most important aspects below.
NSEI:STAR Historical Dividend Yield, September 3rd 2019
Payout ratios
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Strides Pharma Science paid out 36% 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.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Unfortunately, while Strides Pharma Science pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is Strides Pharma Science's Balance Sheet Risky?
As Strides Pharma Science 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 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). Strides Pharma Science has net debt of 4.65 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.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.42 times its interest expense is starting to become a concern for Strides Pharma Science, and be aware that lenders may place additional restrictions on the company as well.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Strides Pharma Science has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was ₹1.50 in 2009, compared to ₹3.00 last year. Dividends per share have grown at approximately 7.2% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we're not certain this dividend stock would be ideal for someone intending to live on the income.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Over the past five years, it looks as though Strides Pharma Science's EPS have declined at around 18% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Strides Pharma Science's earnings per share, which support the dividend, have been anything but stable.
Conclusion
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Strides Pharma Science has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. In summary, Strides Pharma Science has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 8 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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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.
