Investors In Peyto Exploration & Development Corp. (TSE:PEY) Should Consider This, First

Could Peyto Exploration & Development Corp. (TSE:PEY) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the 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 goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Peyto Exploration & Development is a new dividend aristocrat in the making. We’d agree the yield does look enticing. Remember though, given the recent drop in its share price, Peyto Exploration & Development’s yield will look higher, even though the market may now be expecting a decline in its long-term prospects. Some simple research can reduce the risk of buying Peyto Exploration & Development for its dividend – read on to learn more.

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TSX:PEY Historical Dividend Yield, August 5th 2019
TSX:PEY Historical Dividend Yield, August 5th 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. 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 93% of Peyto Exploration & Development’s profits were paid out as dividends in the last 12 months. With a payout ratio this high, we’d say its dividend is not well covered by earnings. This may be fine if earnings are growing, but it might not take much of a downturn for the dividend to come under pressure.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 63% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Peyto Exploration & Development has available to meet other needs. While the dividend was not well covered by profits, at least they were covered by free cash flow. Still, if the company continues paying out such a high percentage of its profits, the dividend could be at risk if business turns sour.

Is Peyto Exploration & Development’s Balance Sheet Risky?

As Peyto Exploration & Development’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 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). With net debt of 2.51 times its EBITDA, Peyto Exploration & Development’s debt burden is within a normal range for most listed companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. With EBIT of 3.85 times its interest expense, Peyto Exploration & Development’s interest cover is starting to look a bit thin.

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. The first recorded dividend for Peyto Exploration & Development, in the last decade, was nine years ago. It’s good to see that Peyto Exploration & Development has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we’re concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was CA$1.44 in 2010, compared to CA$0.24 last year. This works out to a decline of approximately 83% over that time.

We struggle to make a case for buying Peyto Exploration & Development for its dividend, given that payments have shrunk over the past nine years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Over the past five years, it looks as though Peyto Exploration & Development’s EPS have declined at around 7.6% a year. A modest decline in earnings per share is not great to see, but it doesn’t automatically make a dividend unsustainable. Still, we’d vastly prefer to see EPS growth when researching dividend stocks.

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 not keen on the fact that Peyto Exploration & Development paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. In this analysis, Peyto Exploration & Development 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.

Are management backing themselves to deliver performance? Check their shareholdings in Peyto Exploration & Development in our latest insider ownership analysis.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.