How Does Origin Energy Limited (ASX:ORG) Stand Up To These Simple Dividend Safety Checks?

Could Origin Energy Limited (ASX:ORG) 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 stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A high yield and a long history of paying dividends is an appealing combination for Origin Energy. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock during the year, equivalent to approximately 0.6% of the company’s market capitalisation at the time. 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 Origin Energy!

ASX:ORG Historical Dividend Yield, September 6th 2019
ASX:ORG Historical Dividend Yield, September 6th 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. 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 36% of Origin Energy’s profits were paid out as dividends in the last 12 months. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Origin Energy’s cash payout ratio last year was 15%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.

Is Origin Energy’s Balance Sheet Risky?

As Origin Energy 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). With net debt of 6.26 times its EBITDA, Origin Energy could be described as a highly leveraged company. While some companies can handle this level of leverage, we’d be concerned about the dividend sustainability if there was any risk of an earnings downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Interest cover of 4.15 times its interest expense is starting to become a concern for Origin Energy, and be aware that lenders may place additional restrictions on the company as well. Low interest cover and high debt can create problems right when the investor least needs them, and we’re reluctant to rely on the dividend of companies with these traits.

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. For the purpose of this article, we only scrutinise the last decade of Origin Energy’s dividend 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 AU$0.50 in 2009, compared to AU$0.30 last year. This works out to be a decline of approximately 5.0% per year over that time. Origin Energy’s dividend hasn’t shrunk linearly at 5.0% per annum, but the CAGR is a useful estimate of the historical rate of change.

A shrinking dividend over a ten-year period is not ideal, and we’d be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It’s good to see Origin Energy has been growing its earnings per share at 19% a year over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

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. It’s great to see that Origin Energy is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. All things considered, Origin Energy looks like a strong prospect. At the right valuation, it could be something special.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 10 analysts we track are forecasting for Origin Energy 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.