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Could E.ON SE (FRA:EOAN) 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.
In this case, E.ON likely looks attractive to investors, given its 4.8% dividend yield and a payment history of over ten years. We’d guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding E.ON for its dividend, and we’ll focus on the most important aspects below.
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. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. In the last year, E.ON paid out 40% of its profit as dividends. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, E.ON paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is E.ON’s Balance Sheet Risky?
As E.ON has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). E.ON has net debt of 1.98 times its EBITDA, which we think is not too troublesome.
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 3.40 times its interest expense is starting to become a concern for E.ON, and be aware that lenders may place additional restrictions on the company as well.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. E.ON has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During the past ten-year period, the first annual payment was €1.50 in 2009, compared to €0.46 last year. The dividend has fallen 69% over 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. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. E.ON’s earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. E.ON is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
To summarise, shareholders should always check that E.ON’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. E.ON has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. In sum, we find it hard to get excited about E.ON from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 19 analysts we track are forecasting for E.ON 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.