Today we’ll take a closer look at Snam S.p.A. (BIT:SRG) 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, Snam likely looks attractive to investors, given its 6.5% dividend yield and a payment history of over ten years. We’d guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 1.2% of the company’s market capitalisation at the time. Some simple analysis can reduce the risk of holding Snam for its dividend, and we’ll focus on the most important aspects below.
Explore this interactive chart for our latest analysis on Snam!
BIT:SRG Historical Dividend Yield, March 16th 2020
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, Snam paid out 75% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Snam paid out 155% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. 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. While Snam’s dividends were covered by the company’s reported profits, free cash flow is somewhat more important, so it’s not great to see that the company didn’t generate enough cash to pay its dividend. Cash is king, as they say, and were Snam to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.
Is Snam’s Balance Sheet Risky?
As Snam has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with 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. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Snam has net debt of 5.50 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Net interest cover of 9.42 times its interest expense appears reasonable for Snam, although we’re conscious that even high interest cover doesn’t make a company bulletproof. Adequate interest cover may make the debt look safe, relative to companies with a lower interest cover ratio. However with such a large mountain of debt overall, we’re cautious of what could happen if interest rates rise.
Consider getting our latest analysis on Snam’s financial position here.
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. Snam has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was €0.20 in 2010, compared to €0.23 last year. Dividends per share have grown at approximately 1.2% per year over this time. Snam’s dividend payments have fluctuated, so it hasn’t grown 1.2% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company’s earnings are not consistent.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Earnings have grown at around 2.5% a year for the past five years, which is better than seeing them shrink! Snam’s earnings per share have barely grown, which is not ideal – perhaps this is why the company pays out the majority of its earnings to shareholders. When a company prefers to pay out cash to its shareholders instead of reinvesting it, this can often say a lot about that company’s dividend prospects.
Conclusion
To summarise, shareholders should always check that Snam’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is chequered – having cut its dividend at least once in the past. Overall, Snam falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. To that end, Snam has 3 warning signs (and 1 which is potentially serious) we think you should know about.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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.
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