Is Vedanta Limited (NSE:VEDL) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on your dividends, it’s important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you’ll find our analysis useful.
With Vedanta yielding 7.3% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We’d guess that plenty of investors have purchased it for the income. Remember that the recent share price drop will make Vedanta’s yield look higher, even though recent events might have impacted the company’s prospects. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.
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. 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, Vedanta paid out 99% of its profit as dividends. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable – still, we think it is a concern.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Vedanta’s cash payout ratio in the last year was 44%, which suggests dividends were well covered by cash generated by the business. While the dividend was not well covered by profits, at least they were covered by free cash flow. Even so, if the company were to continue paying out almost all of its profits, we’d be concerned about whether the dividend is sustainable in a downturn.
Is Vedanta’s Balance Sheet Risky?
As Vedanta’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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). Vedanta has net debt of 0.85 times its EBITDA, which is generally an okay level of debt for most companies.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 4.13 times its interest expense, Vedanta’s interest cover is starting to look a bit thin.
Consider getting our latest analysis on Vedanta’s financial position here.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Vedanta’s dividend payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was ₹2.25 in 2010, compared to ₹5.75 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.8% a year over that time. The dividends haven’t grown at precisely 9.8% every year, but this is a useful way to average out the historical rate of growth.
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 evaluate if earnings per share (EPS) are growing – it’s not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. While there may be fluctuations in the past , Vedanta’s earnings per share have basically not grown from where they were five years ago. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company’s dividends could be eroded by inflation. This level of earnings growth is low, and the company is paying out 99% of its profit. As they say in finance, ‘past performance is not indicative of future performance’, but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.
To summarise, shareholders should always check that Vedanta’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We’re not keen on the fact that Vedanta paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. In sum, we find it hard to get excited about Vedanta from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. Case in point: We’ve spotted 3 warning signs for Vedanta (of which 1 can’t be ignored!) you should know about.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
If you spot an error that warrants correction, please contact the editor at email@example.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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