Could FirstEnergy Corp. (NYSE:FE) 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. 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.
A high yield and a long history of paying dividends is an appealing combination for FirstEnergy. We’d guess that plenty of investors have purchased it for the income. 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.
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, FirstEnergy paid out 66% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, FirstEnergy paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is FirstEnergy’s Balance Sheet Risky?
As FirstEnergy 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). FirstEnergy has net debt of 5.65 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Interest cover of 2.22 times its interest expense is starting to become a concern for FirstEnergy, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company’s dividend while these metrics persist.
Remember, you can always get a snapshot of FirstEnergy’s latest financial position, by checking our visualisation of its financial health.
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. FirstEnergy has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was US$2.20 in 2010, compared to US$1.56 last year. The dividend has shrunk at around 3.4% a year during that period. FirstEnergy’s dividend hasn’t shrunk linearly at 3.4% per annum, but the CAGR is a useful estimate of the historical rate of change.
When a company’s per-share dividend falls we question if this reflects poorly on either external business conditions, or the company’s capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
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? It’s good to see FirstEnergy has been growing its earnings per share at 20% a year over the past five years. With recent, rapid earnings per share growth and a payout ratio of 66%, this business looks like an interesting prospect if earnings are reinvested effectively.
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. First, we think FirstEnergy has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Ultimately, FirstEnergy comes up short on our dividend analysis. It’s not that we think it is a bad company – just that there are likely more appealing dividend prospects out there on this analysis.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 12 FirstEnergy analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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