Are Dividend Investors Making A Mistake With Eddie Stobart Logistics plc (LON:ESL)?

Could Eddie Stobart Logistics plc (LON:ESL) 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. 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.

In this case, Eddie Stobart Logistics pays a decent-sized 8.9% dividend yield, and has been distributing cash to shareholders for the past two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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AIM:ESL Historical Dividend Yield, August 26th 2019
AIM:ESL Historical Dividend Yield, August 26th 2019

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. Looking at the data, we can see that 142% of Eddie Stobart Logistics’s profits were paid out as dividends in the last 12 months. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, Eddie Stobart Logistics paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Eddie Stobart Logistics’s Balance Sheet Risky?

As Eddie Stobart Logistics’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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). Eddie Stobart Logistics has net debt of 2.63 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Net interest cover of 6.78 times its interest expense appears reasonable for Eddie Stobart Logistics, although we’re conscious that even high interest cover doesn’t make a company bulletproof.

Dividend Volatility

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. The company has been paying a stable dividend for a few years now, but we’d like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was UK£0.028 in 2017, compared to UK£0.063 last year. This works out to be a compound annual growth rate (CAGR) of approximately 50% a year over that time.

Eddie Stobart Logistics has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It’s good to see Eddie Stobart Logistics has been growing its earnings per share at 12% a year over the past 5 years. With a payout ratio of 142%, Eddie Stobart Logistics is paying out substantially more than it earned in dividends. This is a risky practice.

We’d also point out that Eddie Stobart Logistics issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental – it’s hard to grow dividends per share when new shares are regularly being created.

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. Eddie Stobart Logistics paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Unfortunately, there hasn’t been any earnings growth, and the company’s dividend history has been too short for us to evaluate the consistency of the dividend. In summary, Eddie Stobart Logistics has a number of shortcomings that we’d find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 4 analysts we track are forecasting for Eddie Stobart Logistics for free with public analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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.

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.