Is Viva Energy Group Limited (ASX:VEA) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.
In this case, Viva Energy Group pays a decent-sized 3.5% dividend yield, and has been distributing cash to shareholders for the past two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Viva Energy Group paid out 118% 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. Viva Energy Group paid out 68% 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 disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Viva Energy Group fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.
With a strong net cash balance, Viva Energy Group investors may not have much to worry about in the near term from a dividend perspective.
Remember, you can always get a snapshot of Viva Energy Group's latest financial position, by checking our visualisation of its financial health.
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. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past two-year period, the first annual payment was AU$0.06 in 2019, compared to AU$0.06 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.1% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Over the past five years, it looks as though Viva Energy Group's EPS have declined at around 30% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Viva Energy Group's earnings per share, which support the dividend, have been anything but stable.
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 its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. There are a few too many issues for us to get comfortable with Viva Energy Group from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. 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 3 warning signs for Viva Energy Group that investors need to be conscious of moving forward.
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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