Could Italgas S.p.A. (BIT:IG) 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. 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.
In this case, Italgas pays a decent-sized 4.0% dividend yield, and has been distributing cash to shareholders for the past two years. A 4.0% yield does look good. Could the short payment history hint at future dividend growth? Some simple research can reduce the risk of buying Italgas for its dividend – read on to learn more.
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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. In the last year, Italgas paid out 58% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 66% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Italgas has available to meet other needs. It’s positive to see that Italgas’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Italgas’s Balance Sheet Risky?
As Italgas 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). Italgas has net debt of 4.02 times its EBITDA, which is getting towards the limit of most investors’ comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Italgas has interest cover of more than 12 times its interest expense, which we think is quite strong.
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. The dividend has not fluctuated much, but with a relatively short payment history, we can’t be sure this is sustainable across a full market cycle. During the past two-year period, the first annual payment was €0.20 in 2017, compared to €0.23 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.2% a year over that time.
Italgas has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.
Dividend Growth Potential
Examining whether the dividend is affordable and stable is important. However, it’s also important to assess if 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. Italgas’s earnings per share have shrunk at 20% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Italgas’s earnings per share, which support the dividend, have been anything but stable.
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. First, we think Italgas is paying out an acceptable percentage of its cashflow and profit. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend’s consistency across an economic cycle. In summary, Italgas 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.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 15 analysts we track are forecasting for the future.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.