Three Things You Should Check Before Buying Bega Cheese Limited (ASX:BGA) For Its Dividend

Today we'll take a closer look at Bega Cheese Limited (ASX:BGA) 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 a 1.9% yield and a nine-year payment history, investors probably think Bega Cheese looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. Some simple analysis can reduce the risk of holding Bega Cheese for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Bega Cheese!

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. Bega Cheese paid out 101% of its profit as dividends, over the trailing twelve month period. This is quite a high payout ratio that suggests the dividend is not well covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Bega Cheese paid out 24% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Bega Cheese fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Consider getting our latest analysis on Bega Cheese's financial position 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. The first recorded dividend for Bega Cheese, in the last decade, was nine years ago. Its dividend has not fluctuated much that time, which we like, but we're conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past nine-year period, the first annual payment was AU$0.06 in 2011, compared to AU$0.1 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.8% a year over that time.

Bega Cheese has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.

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. Earnings have grown at around 4.1% a year for the past five years, which is better than seeing them shrink! Still, the company has struggled to grow its EPS, and currently pays out 101% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

Conclusion

To summarise, shareholders should always check that Bega Cheese's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Bega Cheese out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic 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 Bega Cheese that investors should know about before committing capital to this stock.

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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