Should You Buy Molson Coors Canada Inc. (TSE:TPX.B) For Its 4.2% Dividend?

Today we'll take a closer look at Molson Coors Canada Inc. (TSE:TPX.B) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a five-year payment history and a 4.2% yield, many investors probably find Molson Coors Canada intriguing. We'd agree the yield does look enticing. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. While Molson Coors Canada pays a dividend, it reported a loss over the last year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Unfortunately, while Molson Coors Canada pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Is Molson Coors Canada's Balance Sheet Risky?

Given Molson Coors Canada is paying a dividend but reported a loss over the past year, 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. Molson Coors Canada has net debt of 19.57 times its EBITDA, which we think carries substantial risk if earnings aren't sustainable.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Molson Coors Canada has interest cover of less than 1 - which suggests its earnings are not high enough to cover even the interest payments on its debt. This is potentially quite serious, and we would likely avoid the stock if it were not resolved quickly. Low interest cover and high debt can create problems right when the investor least needs them, and we're reluctant to rely on the dividend of companies with these traits.

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. Molson Coors Canada has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$1.46 in 2014, compared to US$2.22 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.7% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Molson Coors Canada might have put its house in order since then, but we remain cautious.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Molson Coors Canada has grown its earnings per share at 78% per annum over the past five years.

Conclusion

To summarise, shareholders should always check that Molson Coors Canada's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with Molson Coors Canada paying a dividend while loss-making, especially since the dividend was also not well covered by free cash flow. 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. Overall, Molson Coors Canada falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Now, if you want to look closer, it would be worth checking out our free research on Molson Coors Canada management tenure, salary, and performance.

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.