Stock Analysis

How Does GWA Group Limited (ASX:GWA) Fare As A Dividend Stock?

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ASX:GWA
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Is GWA Group Limited (ASX:GWA) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

In this case, GWA Group likely looks attractive to investors, given its 6.8% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. There are a few simple ways to reduce the risks of buying GWA Group for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

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ASX:GWA Historic Dividend August 8th 2020

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. GWA Group paid out 108% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 139%, GWA Group's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. As GWA Group's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Is GWA Group's Balance Sheet Risky?

As GWA Group'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). GWA Group has net debt of 1.90 times its EBITDA, which is generally an okay level of debt for most companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. GWA Group has interest cover of more than 12 times its interest expense, which we think is quite strong.

Remember, you can always get a snapshot of GWA Group'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. For the purpose of this article, we only scrutinise the last decade of GWA Group's dividend payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was AU$0.2 in 2010, compared to AU$0.2 last year. The dividend has shrunk at a rate of less than 1% a year over this period.

A shrinking dividend over a 10-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, 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. GWA Group has grown its earnings per share at 9.8% per annum over the past five years. Although per-share earnings are growing at a credible rate, virtually all of the income is being paid out as dividends to shareholders. This is okay, but may limit growth in the company's future dividend payments.

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 GWA Group paying out a high percentage of both its cashflow and earnings. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Overall, GWA Group falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 2 warning signs for GWA Group 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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