Read This Before Buying Z Energy Limited (NZSE:ZEL) For Its Dividend

Today we’ll take a closer look at Z Energy Limited (NZSE:ZEL) 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.

In this case, Z Energy likely looks attractive to dividend investors, given its 6.5% dividend yield and six-year payment history. It sure looks interesting on these metrics – but there’s always more to the story . Some simple analysis can reduce the risk of holding Z Energy for its dividend, and we’ll focus on the most important aspects below.

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NZSE:ZEL Historical Dividend Yield, August 18th 2019
NZSE:ZEL Historical Dividend Yield, August 18th 2019

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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 91% of Z Energy’s profits were paid out as dividends in the last 12 months. This is quite a high payout ratio that suggests the dividend is not well covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Z Energy paid out 70% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It’s good to see that while Z Energy’s dividends were not well covered by profits, at least they are affordable from a free cash flow perspective. Even so, if the company were to continue paying out almost all of its profits, we’d be concerned about whether the dividend is sustainable in a downturn.

Is Z Energy’s Balance Sheet Risky?

As Z Energy’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 1.92 times its EBITDA, Z Energy 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. Z Energy has EBIT of 6.42 times its interest expense, which we think is adequate.

Dividend Volatility

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. Z Energy has been paying a dividend for the past six years. Its dividend has not fluctuated much that time, which we like, but we’re conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past six-year period, the first annual payment was NZ$0.15 in 2013, compared to NZ$0.43 last year. Dividends per share have grown at approximately 19% per year over this time.

We’re not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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. Z Energy has grown its earnings per share at 3.8% per annum over the past five years. This level of earnings growth is low, and the company is paying out 91% of its profit. Limited recent earnings growth and a high payout ratio makes it hard for us to envision strong future dividend growth, unless the company should have substantial pricing power or some form of competitive advantage.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We’re not keen on the fact that Z Energy paid out such a high percentage of its income, although its cashflow is in better shape. 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. With this information in mind, we think Z Energy may not be an ideal dividend stock.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 Z Energy analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.