Could Southern Cross Electrical Engineering Limited (ASX:SXE) Have The Makings Of Another Dividend Aristocrat?

Is Southern Cross Electrical Engineering Limited (ASX:SXE) 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.

With Southern Cross Electrical Engineering yielding 5.5% 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. There are a few simple ways to reduce the risks of buying Southern Cross Electrical Engineering for its dividend, and we'll go through these below.

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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. 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. Looking at the data, we can see that 67% of Southern Cross Electrical Engineering's profits were paid out as dividends in the last 12 months. 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. Southern Cross Electrical Engineering paid out 74% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's positive to see that Southern Cross Electrical Engineering's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

With a strong net cash balance, Southern Cross Electrical Engineering investors may not have much to worry about in the near term from a dividend perspective.

We update our data on Southern Cross Electrical Engineering every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of Southern Cross Electrical Engineering'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$0.07 in 2010, compared to AU$0.03 last year. This works out to be a decline of approximately 7.4% per year over that time. Southern Cross Electrical Engineering's dividend hasn't shrunk linearly at 7.4% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying Southern Cross Electrical Engineering for its dividend, given that payments have shrunk over the past 10 years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Southern Cross Electrical Engineering has grown its earnings per share at 60% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 67%, this business looks like an interesting prospect if earnings are reinvested effectively.

We'd also point out that Southern Cross Electrical Engineering issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that Southern Cross Electrical Engineering's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Southern Cross Electrical Engineering's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Ultimately, Southern Cross Electrical Engineering comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 1 warning sign for Southern Cross Electrical Engineering that investors should know about before committing capital to this stock.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.
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