Three Things You Should Check Before Buying Terreno Realty Corporation (NYSE:TRNO) For Its Dividend

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Today we’ll take a closer look at Terreno Realty Corporation (NYSE:TRNO) 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.

Investors might not know much about Terreno Realty’s dividend prospects, even though it has been paying dividends for the last eight years and offers a 1.9% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. Some simple analysis can reduce the risk of holding Terreno Realty for its dividend, and we’ll focus on the most important aspects below.

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NYSE:TRNO Historical Dividend Yield, July 12th 2019
NYSE:TRNO Historical Dividend Yield, July 12th 2019

Payout ratios

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. Looking at the data, we can see that 68% of Terreno Realty’s profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.

We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Terreno Realty paid out 65% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It’s positive to see that Terreno Realty’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.

Terreno Realty is a REIT, which is an investment structure that often has different payout rules compared to other companies. It is not uncommon for REITs to pay out 100% of their earnings each year.

Is Terreno Realty’s Balance Sheet Risky?

As Terreno Realty 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). Terreno Realty is carrying net debt of 4.33 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

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 3.90 times its interest expense is starting to become a concern for Terreno Realty, and be aware that lenders may place additional restrictions on the company as well.

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 first recorded dividend for Terreno Realty, in the last decade, was eight years ago. The dividend has been quite stable over the past eight years, which is great to see – although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past eight-year period, the first annual payment was US$0.40 in 2011, compared to US$0.96 last year. Dividends per share have grown at approximately 12% per year over this time.

Terreno Realty has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Terreno Realty has grown its earnings per share at 45% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 68%, this business looks like an interesting prospect if earnings are reinvested effectively.

We’d also point out that Terreno Realty issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental – it’s hard to grow dividends per share when new shares are regularly being created.

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. Terreno Realty’s is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we’d like. In sum, we find it hard to get excited about Terreno Realty 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 10 analysts we track are forecasting for Terreno Realty for free with public analyst estimates for the company.

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.