Tread With Caution Around Air Arabia PJSC's (DFM:AIRARABIA) 6.9% Dividend Yield

Dividend paying stocks like Air Arabia PJSC (DFM:AIRARABIA) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A high yield and a long history of paying dividends is an appealing combination for Air Arabia PJSC. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

Payout ratios

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. Although Air Arabia PJSC pays a dividend, it was loss-making during the past year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

The company paid out 58% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Air Arabia PJSC has available to meet other needs.

While the above analysis focuses on dividends relative to a company's earnings, we do note Air Arabia PJSC's strong net cash position, which will let it pay larger dividends for a time, should it choose.

Remember, you can always get a snapshot of Air Arabia PJSC's latest financial position, by checking our visualisation of its financial health.

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. Air Arabia PJSC has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was د.إ0.1 in 2011, compared to د.إ0.09 last year. The dividend has shrunk at around 1.0% a year during that period. Air Arabia PJSC's dividend hasn't shrunk linearly at 1.0% per annum, but the CAGR is a useful estimate of the historical rate of change.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

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. Over the past five years, it looks as though Air Arabia PJSC's EPS have declined at around 16% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Air Arabia PJSC's earnings per share, which support the dividend, have been anything but stable.

Conclusion

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. We're a bit uncomfortable with the company paying a dividend while being loss-making, although at least the dividend was covered by free cash flow. Earnings per share are down, and Air Arabia PJSC's dividend has been cut at least once in the past, which is disappointing. In this analysis, Air Arabia PJSC 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 compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. Taking the debate a bit further, we've identified 1 warning sign for Air Arabia PJSC that investors need to be conscious of moving forward.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.
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