Could Oceania Healthcare Limited (NZSE:OCA) 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.
Oceania Healthcare yields a solid 4.3%, although it has only been paying for two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 63% of Oceania Healthcare’s profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 173%, Oceania Healthcare’s dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Oceania Healthcare paid out less in dividends than it reported in profits, but unfortunately it didn’t generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Oceania Healthcare to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.
Is Oceania Healthcare’s Balance Sheet Risky?
As Oceania Healthcare 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 is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With a net debt to EBITDA ratio of 18.36 times, Oceania Healthcare is very highly levered. While this debt might be serviceable, we would still say it carries substantial risk for the investor who hopes to live on the dividend.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Oceania Healthcare has EBIT of 10.14 times its interest expense, which we think is adequate. Despite a decent level of interest cover, shareholders should remain cautious about the high level of net debt. Rising rates or tighter debt markets have a nasty habit of making fools of highly-indebted dividend stocks.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The dividend has not fluctuated much, but with a relatively short payment history, we can’t be sure this is sustainable across a full market cycle. During the past two-year period, the first annual payment was NZ$0.042 in 2017, compared to NZ$0.047 last year. Dividends per share have grown at approximately 5.8% per year over this time.
The dividend has been growing at a reasonable rate, which we like. We’re conscious though that one of the best ways to detect a multi-decade consistent dividend-payer, is to watch a company pay dividends for 20 years – a distinction Oceania Healthcare has not achieved yet.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend’s purchasing power over the long term. It’s good to see Oceania Healthcare has been growing its earnings per share at 54% a year over the past five years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that Oceania Healthcare’s growth will be slower in the future.
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 Oceania Healthcare has an acceptable payout ratio, although its dividend was not well covered by cashflow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we’d like. In sum, we find it hard to get excited about Oceania Healthcare 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.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 4 analysts we track are forecasting for Oceania Healthcare 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%.
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