Stock Analysis

Is Bapcor Limited (ASX:BAP) A Smart Pick For Income Investors?

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ASX:BAP
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Dividend paying stocks like Bapcor Limited (ASX:BAP) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

Investors might not know much about Bapcor's dividend prospects, even though it has been paying dividends for the last five years and offers a 3.0% yield. A 3.0% yield is not inspiring, but the longer payment history has some appeal. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Bapcor!

historic-dividend
ASX:BAP Historic Dividend July 25th 2020

Payout ratios

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. Looking at the data, we can see that 51% of Bapcor's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend 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. Of the free cash flow it generated last year, Bapcor paid out 40% as dividends, suggesting the dividend is affordable. It's positive to see that Bapcor'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.

Is Bapcor's Balance Sheet Risky?

As Bapcor has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). Bapcor has net debt of 2.36 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Bapcor has EBIT of 8.70 times its interest expense, which we think is adequate.

We update our data on Bapcor 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. Looking at the data, we can see that Bapcor has been paying a dividend for the past five years. During the past five-year period, the first annual payment was AU$0.08 in 2015, compared to AU$0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 17% a year over that time.

Bapcor has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Bapcor has grown its earnings per share at 96% per annum over the past five years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that Bapcor's growth will be slower in the future.

Conclusion

To summarise, shareholders should always check that Bapcor's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Bapcor's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Bapcor has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

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 Bapcor 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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