Today we’ll take a closer look at National Grid plc (LON:NG.) from a dividend investor’s perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. If you are hoping to live on your dividends, it’s important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you’ll find our analysis useful.
With National Grid yielding 4.9% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We’d guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding National Grid for its dividend, and we’ll focus on the most important aspects 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, National Grid paid out 112% of its profit as dividends. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. With a cash payout ratio of 1083%, National Grid’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. Cash is slightly more important than profit from a dividend perspective, but given National Grid’s payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.
Is National Grid’s Balance Sheet Risky?
As National Grid’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 5.69 times its EBITDA, National Grid 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 3.63 times its interest expense is starting to become a concern for National Grid, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company’s dividend while these metrics persist.
We update our data on National Grid 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. National Grid has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was UK£0.39 in 2010, compared to UK£0.48 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.1% a year over that time.
Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.
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. Over the past five years, it looks as though National Grid’s EPS have declined at around 9.7% a year. A modest decline in earnings per share is not great to see, but it doesn’t automatically make a dividend unsustainable. Still, we’d vastly prefer to see EPS growth when researching dividend stocks.
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 a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. It’s not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. In this analysis, National Grid doesn’t shape up too well as a dividend stock. We’d find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Market movements attest to how highly valued a consistent dividend policy is to one to which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Case in point: We’ve spotted 4 warning signs for National Grid (of which 1 is a bit unpleasant!) you should know about.
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.
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