Is Gibson Energy Inc. (TSE:GEI) At Risk Of Cutting Its Dividend?

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Dividend paying stocks like Gibson Energy Inc. (TSE:GEI) tend to be popular with investors, and for good reason - some research shows that a significant amount of all stock market returns come from reinvested dividends. 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.

With a eight-year payment history and a 6.0% yield, many investors probably find Gibson Energy intriguing. We'd agree the yield does look enticing. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Gibson Energy paid out 234% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Gibson Energy paid out 57% of its cash flow as dividends last year, which does not seem unusual.

Is Gibson Energy's Balance Sheet Risky?

As Gibson Energy'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). Gibson Energy has net debt of 2.89 times its earnings before interest, tax, depreciation, and amortisation (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. Interest cover of less than 5x its interest expense is starting to become a concern for Gibson Energy, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of Gibson Energy'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. Looking at the last decade of data, we can see that Gibson Energy paid its first dividend at least eight years ago. The dividend has been quite stable over the past eight years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past eight-year period, the first annual payment was CA$0.96 in 2011, compared to CA$1.32 last year. Dividends per share have grown at approximately 4.1% per year over this time.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. In the last five years, Gibson Energy's earnings per share have shrunk at approximately 8.0% per annum. 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.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're a bit uncomfortable with its high payout ratio, although we note cashflow was stronger than income. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. There are a few too many issues for us to get comfortable with Gibson Energy from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

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.