Does St. Modwen Properties PLC (LON:SMP) Have A Place In Your Dividend Stock Portfolio?

Could St. Modwen Properties PLC (LON:SMP) 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 popular dividend stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.

Investors might not know much about St. Modwen Properties’s dividend prospects, even though it has been paying dividends for the last nine years and offers a 1.7% yield. While the yield may not look too great, the relatively long payment history is interesting. Before you buy any stock for its dividend however, you should always remember Warren Buffett’s two rules: 1) Don’t lose money, and 2) Remember rule #1. We’ll run through some checks below to help with this.

Explore this interactive chart for our latest analysis on St. Modwen Properties!

LSE:SMP Historical Dividend Yield, September 8th 2019
LSE:SMP Historical Dividend Yield, September 8th 2019

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. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. In the last year, St. Modwen Properties paid out 27% of its profit as dividends. 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. St. Modwen Properties paid out 243% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While St. Modwen Properties’s dividends were covered by the company’s reported profits, free cash flow is somewhat more important, so it’s not great to see that the company didn’t generate enough cash to pay its dividend. Cash is king, as they say, and were St. Modwen Properties to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.

Is St. Modwen Properties’s Balance Sheet Risky?

As St. Modwen Properties 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 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). With net debt of 4.18 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. St. Modwen Properties has EBIT of 6.48 times its interest expense, which we think is adequate.

Dividend Volatility

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. The first recorded dividend for St. Modwen Properties, in the last decade, was nine years ago. It’s good to see that St. Modwen Properties has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we’re concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was UK£0.02 in 2010, compared to UK£0.071 last year. Dividends per share have grown at approximately 15% 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.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

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 St. Modwen Properties’s EPS have declined at around 3.4% a year. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

Conclusion

To summarise, shareholders should always check that St. Modwen Properties’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, the company has a conservative payout ratio, although we’d note that its cashflow in the past year was substantially lower than its reported profit. Earnings per share are down, and St. Modwen Properties’s dividend has been cut at least once in the past, which is disappointing. In summary, St. Modwen Properties 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.

Now, if you want to look closer, it would be worth checking out our free research on St. Modwen Properties management tenure, salary, and performance.

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.