Should Hindustan Zinc Limited (NSE:HINDZINC) Be Part Of Your Income Portfolio?

Today we'll take a closer look at Hindustan Zinc Limited (NSE:HINDZINC) 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. 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.

In this case, Hindustan Zinc likely looks attractive to investors, given its 8.8% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. 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

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. Hindustan Zinc paid out 255% 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. Hindustan Zinc paid out 199% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Cash is slightly more important than profit from a dividend perspective, but given Hindustan Zinc's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

With a strong net cash balance, Hindustan Zinc investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of Hindustan Zinc's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Hindustan Zinc has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was ₹0.6 in 2010, compared to ₹21.3 last year. Dividends per share have grown at approximately 43% per year over this 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 not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Over the past five years, it looks as though Hindustan Zinc's EPS have declined at around 6.1% 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

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 Hindustan Zinc paying out a high percentage of both its cashflow and earnings. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. In this analysis, Hindustan Zinc 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.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've identified 2 warning signs for Hindustan Zinc (1 shouldn't be ignored!) that you should be aware of before investing.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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