Is K-Bro Linen Inc. (TSE:KBL) A Good Dividend Stock?

Could K-Bro Linen Inc. (TSE:KBL) be an attractive dividend share to own for the long haul? Investors are often drawn to a company for its dividend. 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, K-Bro Linen likely looks attractive to investors, given its 3.1% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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TSX:KBL Historical Dividend Yield, April 18th 2019
TSX:KBL Historical Dividend Yield, April 18th 2019

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. 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 204% of K-Bro Linen’s profits were paid out as dividends in the last 12 months. 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. Unfortunately, while K-Bro Linen pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it’s not ideal from a dividend perspective.

Is K-Bro Linen’s Balance Sheet Risky?

As K-Bro Linen’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 a company’s total debt load relative to its earnings (lower = less debt), while net interest cover measures the company’s ability to pay the interest on its debt (higher = greater ability to pay interest costs). With net debt of more than twice its EBITDA, K-Bro Linen has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Interest cover of less than 5x its interest expense is starting to become a concern for K-Bro Linen, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of K-Bro Linen’s latest financial position, by checking our visualisation of its financial health.

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. For the purpose of this article, we only scrutinise the last decade of K-Bro Linen’s dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was CA$1.10 in 2009, compared to CA$1.20 last year. Dividend payments have grown at less than 1% a year over this period.

Dividend Growth Potential

While dividend payments have been relatively stable, 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. It’s not great to see that K-Bro Linen’s have fallen at approximately -17% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

We’d also point out that K-Bro Linen issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental – it’s hard to grow dividends per share when new shares are regularly being created.

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. K-Bro Linen paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. It’s not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. In this analysis, K-Bro Linen doesn’t shape up too well as a dividend stock. We’d find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend payer.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.