Is Biffa plc (LON:BIFF) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.
Some readers mightn’t know much about Biffa’s 2.9% dividend, as it has only been paying distributions for the last three years. Many of the best dividend stocks typically start out paying a low yield, so we wouldn’t automatically cut it from our list of prospects. Some simple analysis can reduce the risk of holding Biffa for its dividend, and we’ll focus on the most important aspects below.
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LSE:BIFF Historical Dividend Yield, March 12th 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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Biffa paid out 94% of its profit as dividends. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable – still, we think it is a concern.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Biffa’s cash payout ratio last year was 19%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It’s good to see that while Biffa’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 Biffa’s Balance Sheet Risky?
As Biffa’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 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). Biffa has net debt of 1.67 times its EBITDA, which we think is not too troublesome.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 2.06 times its interest expense, Biffa’s interest cover is starting to look a bit thin.
Consider getting our latest analysis on Biffa’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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we’re not ready to live on. During the past three-year period, the first annual payment was UK£0.058 in 2017, compared to UK£0.072 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.7% a year over that time. Biffa’s dividend payments have fluctuated, so it hasn’t grown 7.7% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we’re not certain this dividend stock would be ideal for someone intending to live on the income.
Dividend Growth Potential
With a relatively unstable dividend, it’s even more important to evaluate if earnings per share (EPS) are growing – it’s not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Over the past five years, it looks as though Biffa’s EPS have declined at around 32% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Biffa’s earnings per share, which support the dividend, have been anything but stable.
Conclusion
To summarise, shareholders should always check that Biffa’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We’re not keen on the fact that Biffa paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. In summary, Biffa 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.
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. Just as an example, we’ve come accross 2 warning signs for Biffa you should be aware of, and 1 of them is potentially serious.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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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