Is ALLETE, Inc. (NYSE:ALE) A Smart Pick For Income Investors?

Could ALLETE, Inc. (NYSE:ALE) be an attractive dividend share to own for the long haul? Investors are often drawn to a company for its dividend. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests ALLETE has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on ALLETE!

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. 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 66% of ALLETE's profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio 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. ALLETE paid out 95% of its free cash last year. Cash flows can be lumpy, but paying out this much cash is not ideal.

Is ALLETE's Balance Sheet Risky?

As ALLETE has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks.

A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. With net debt of above 3x EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

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 less than 5x its interest expense is starting to become a concern for ALLETE, and be aware that lenders may place additional restrictions on the company as well.

We update our data on ALLETE every 24 hours, so you can always get our latest analysis of its financial health, here.

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. ALLETE has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.76 in 2009, compared to US$2.35 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.9% a year over that time.

Dividend Growth Potential

While dividend payments have been relatively stable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Earnings have grown at around 5.2% a year for the past five years, which is better than seeing them shrink! Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.

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. ALLETE gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than ALLETE out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 3 ALLETE analysts we track are forecasting continued growth with our freereport on 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.