Is Kinder Morgan Canada Limited (TSE:KML) An Attractive Dividend Stock?

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Today we’ll take a closer look at Kinder Morgan Canada Limited (TSE:KML) 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 the income from dividends, it’s important to be a lot more stringent with your investments than the average punter.

In this case, Kinder Morgan Canada pays a decent-sized 5.5% dividend yield, and has been distributing cash to shareholders for the past two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. The company also bought back stock during the year, equivalent to approximately 288% of the company’s market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.

Explore this interactive chart for our latest analysis on Kinder Morgan Canada!

TSX:KML Historical Dividend Yield, May 29th 2019
TSX:KML Historical Dividend Yield, May 29th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Although it reported a loss over the past 12 months, Kinder Morgan Canada currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Last year, Kinder Morgan Canada paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

We update our data on Kinder Morgan Canada every 24 hours, so you can always get our latest analysis of its financial health, 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 company has been paying a stable dividend for a few years now, but we’d like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was CA$1.95 in 2017, compared to CA$0.65 last year. Dividend payments have fallen sharply, down 67% over that time.

When a company’s per-share dividend falls we question if this reflects poorly on either the business or management. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. Kinder Morgan Canada’s earnings per share have fallen -717% over the past year. This is a pretty serious concern, and it would be worth investigating whether something fundamental in the business has changed – or broken. We do note though, one year is too short a time to be drawing strong conclusions about a company’s future prospects.

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. It’s a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. Earnings per share are down, and to our mind Kinder Morgan Canada has not been paying a dividend long enough to demonstrate its resilience across economic cycles. Using these criteria, Kinder Morgan Canada looks quite suboptimal from a dividend investment perspective.

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.