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Could TORC Oil & Gas Ltd. (TSE:TOG) 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. 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.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if TORC Oil & Gas is a new dividend aristocrat in the making. It sure looks interesting on these metrics – but there’s always more to the story . Some simple analysis can reduce the risk of holding TORC Oil & Gas for its dividend, and we’ll focus on the most important aspects below.
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. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. TORC Oil & Gas paid out 307% 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. TORC Oil & Gas paid out a conservative 37% of its free cash flow as dividends last year. It’s good to see that while TORC Oil & Gas’s dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we’d be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.
Is TORC Oil & Gas’s Balance Sheet Risky?
As TORC Oil & Gas’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick way to check a company’s financial situation uses these 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. TORC Oil & Gas has net debt of 1.16 times its earnings before interest, tax, depreciation and amortisation (EBITDA), which is generally seen as an acceptable level of debt.
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 TORC Oil & Gas, and be aware that lenders may place additional restrictions on the company as well.
Consider getting our latest analysis on TORC Oil & Gas’s financial position here.
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. TORC Oil & Gas has been paying a dividend for the past six years. 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 six-year period, the first annual payment was CA$0.50 in 2013, compared to CA$0.30 last year. The dividend has shrunk at around 8.2% a year during that period.
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. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see TORC Oil & Gas has grown its earnings per share at 21% per annum over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we’d want to pay extra attention to any fragilities in the company’s balance sheet.
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. We’re a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. We were also glad to see it growing earnings, although its dividend history is not as long as we’d like. While we’re not hugely bearish on it, overall we think there are potentially better dividend stocks than TORC Oil & Gas out there.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 5 analysts we track are forecasting for TORC Oil & Gas for free with public analyst estimates for the company.
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 firstname.lastname@example.org. 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.