Is MTY Food Group Inc. (TSE:MTY) A Smart Choice For Dividend Investors?

Is MTY Food Group Inc. (TSE:MTY) 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.

One way to look into the risks is to look at a snapshot of MTY Food Group's latest financial position, by checking our visualisation of its financial health.

With a 1.3% yield and a nine-year payment history, investors probably think MTY Food Group 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 offer a lot of insights when buying a company for its dividend, and we'll go through this below.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 22% of MTY Food Group's profits were paid out as dividends in the last 12 months. We'd say its dividends are thoroughly covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. MTY Food Group paid out 17% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that MTY Food Group'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 MTY Food Group's Balance Sheet Risky?

As MTY Food Group has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. MTY Food Group has net debt of 3.71 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. MTY Food Group has EBIT of 7.81 times its interest expense, which we think is adequate.

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 last decade of data, we can see that MTY Food Group paid its first dividend at least 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 CA$0.18 in 2010, compared to CA$0.66 last year. This works out to be a compound annual growth rate (CAGR) of approximately 16% a year over that time.

MTY Food Group 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

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see MTY Food Group has grown its earnings per share at 17% per annum over the past five years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.

Conclusion

To summarise, shareholders should always check that MTY Food Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that MTY Food Group is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. MTY Food Group performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 MTY Food Group analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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