Could Leidos Holdings, Inc. (NYSE:LDOS) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
With a 1.5% yield and a seven-year payment history, investors probably think Leidos Holdings looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock equivalent to around 4.4% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Leidos Holdings for its dividend, and we’ll go through these below.
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, Leidos Holdings paid out 29% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase the payout ratio over time.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Leidos Holdings’s cash payout ratio last year was 23%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It’s positive to see that Leidos Holdings’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 Leidos Holdings’s Balance Sheet Risky?
As Leidos Holdings 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 2.35 times its EBITDA, Leidos Holdings’s debt burden is within a normal range for most listed companies.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Net interest cover of 5.63 times its interest expense appears reasonable for Leidos Holdings, although we’re conscious that even high interest cover doesn’t make a company bulletproof.
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. Leidos Holdings has been paying a dividend for the past seven years. It’s good to see that Leidos Holdings 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 seven-year period, the first annual payment was US$1.92 in 2012, compared to US$1.28 last year. This works out to be a decline of approximately 5.6% per year over that time. Leidos Holdings’s dividend hasn’t shrunk linearly at 5.6% per annum, but the CAGR is a useful estimate of the historical rate of change.
A shrinking dividend over a seven-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
With a relatively unstable dividend, and a poor history of shrinking dividends, it’s even more important to see if EPS are growing. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Leidos Holdings has grown its earnings per share at 36% per annum over the past five years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. First, we like that the company’s dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. Overall we think Leidos Holdings scores well on our analysis. It’s not quite perfect, but we’d definitely be keen to take a closer look.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 9 Leidos Holdings analysts we track are forecasting continued growth with our free report on 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%.
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