Do Investors Have Good Reason To Be Wary Of Whitecap Resources Inc.’s (TSE:WCP) 8.6% Dividend Yield?

Dividend paying stocks like Whitecap Resources Inc. (TSE:WCP) tend to be popular with investors, and for good reason – some research suggests 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 goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Whitecap Resources is a new dividend aristocrat in the making. It sure looks interesting on these metrics – but there’s always more to the story . The company also bought back stock equivalent to around 1.9% of market capitalisation this year. 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 Whitecap Resources!

TSX:WCP Historical Dividend Yield, August 14th 2019
TSX:WCP Historical Dividend Yield, August 14th 2019

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company’s net income after tax. Whitecap Resources paid out 163% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Whitecap Resources paid out a conservative 45% of its free cash flow as dividends last year. It’s disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Whitecap Resources fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we’d view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is Whitecap Resources’s Balance Sheet Risky?

As Whitecap Resources’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 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. With net debt of 1.31 times its EBITDA, Whitecap Resources has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 3.36 times its interest expense, Whitecap Resources’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. Looking at the data, we can see that Whitecap Resources has been paying a dividend for the past seven years. The dividend has been quite stable over the past seven 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 seven-year period, the first annual payment was CA$0.60 in 2012, compared to CA$0.34 last year. This works out to be a decline of approximately 7.7% per year over that time.

A shrinking dividend over a seven-year period is not ideal, and we’d be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

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. It’s not great to see that Whitecap Resources’s have fallen at approximately 5.9% over the past five years. 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

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. Unfortunately, there hasn’t been any earnings growth, and the company’s dividend history has been too short for us to evaluate the consistency of the dividend. In summary, Whitecap Resources has a number of shortcomings that we’d find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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 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.