Is Kansas City Southern (NYSE:KSU) A Great Dividend Stock?

Could Kansas City Southern (NYSE:KSU) 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 Kansas City Southern’s dividend prospects, even though it has been paying dividends for the last eight years and offers a 0.9% yield. While the yield may not look too great, the relatively long payment history is interesting. During the year, the company also conducted a buyback equivalent to around 4.7% of its market capitalisation. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.

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NYSE:KSU Historical Dividend Yield, February 14th 2020
NYSE:KSU Historical Dividend Yield, February 14th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Kansas City Southern paid out 27% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Kansas City Southern paid out 30% as dividends, suggesting the dividend is affordable. It’s positive to see that Kansas City Southern’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Kansas City Southern’s Balance Sheet Risky?

As Kansas City Southern 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 2.20 times its EBITDA, Kansas City Southern has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Kansas City Southern has EBIT of 9.10 times its interest expense, which we think is adequate.

We update our data on Kansas City Southern every 24 hours, so you can always get our latest analysis of its financial health, here.

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 Kansas City Southern, in the last decade, was eight years ago. Its dividend has not fluctuated much that time, which we like, but we’re conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past eight-year period, the first annual payment was US$0.78 in 2012, compared to US$1.60 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.4% a year over that time.

Kansas City Southern has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.

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. Earnings have grown at around 3.5% a year for the past five years, which is better than seeing them shrink! Kansas City Southern is paying out less than half of its earnings, which we like. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

Conclusion

To summarise, shareholders should always check that Kansas City Southern’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It’s great to see that Kansas City Southern is paying out a low percentage of its earnings and cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we’d like. Overall we think Kansas City Southern is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 17 Kansas City Southern 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 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.

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. Thank you for reading.