Is Peet Limited (ASX:PPC) An Attractive Dividend Stock?

Is Peet Limited (ASX:PPC) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

In this case, Peet likely looks attractive to investors, given its 5.2% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. That said, the recent jump in the share price will make Peet's dividend yield look smaller, even though the company prospects could be improving. There are a few simple ways to reduce the risks of buying Peet for its dividend, and we'll go through these below.

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Payout ratios

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Peet paid out 57% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift 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. Unfortunately, while Peet pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Is Peet's Balance Sheet Risky?

As Peet 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). Peet has net debt of 5.80 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. Net interest cover of 5.37 times its interest expense appears reasonable for Peet, although we're conscious that even high interest cover doesn't make a company bulletproof. 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.

Consider getting our latest analysis on Peet's financial position here.

Dividend Volatility

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. Peet has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was AU$0.07 in 2010, compared to AU$0.05 last year. The dividend has shrunk at around 3.3% a year during that period. Peet's dividend has been cut sharply at least once, so it hasn't fallen by 3.3% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying Peet for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. In the last five years, Peet's earnings per share have shrunk at approximately 2.7% per annum. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

To summarise, shareholders should always check that Peet's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Peet gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Earnings per share are down, and Peet's dividend has been cut at least once in the past, which is disappointing. Using these criteria, Peet looks quite suboptimal from a dividend investment perspective.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we've identified 5 warning signs for Peet (1 can't be ignored!) that you should be aware of before investing.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.