Yahoo Finance Tread With Caution Around McMillan Shakespeare Limited's (ASX:MMS) 6.1% Dividend Yield
Today we'll take a closer look at McMillan Shakespeare Limited (ASX:MMS) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.
A high yield and a long history of paying dividends is an appealing combination for McMillan Shakespeare. We'd guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. McMillan Shakespeare paid out 96% of its profit as dividends, over the trailing twelve month period. 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. McMillan Shakespeare paid out 54% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. While the dividend was not well covered by profits, at least they were covered by free cash flow. Still, if the company continues paying out such a high percentage of its profits, the dividend could be at risk if business turns sour.
Is McMillan Shakespeare's Balance Sheet Risky?
As McMillan Shakespeare's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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. McMillan Shakespeare has net debt of 0.95 times its EBITDA, which is generally an okay level of debt for most companies.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. McMillan Shakespeare has interest cover of more than 12 times its interest expense, which we think is quite strong.
We update our data on McMillan Shakespeare 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. McMillan Shakespeare has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was AU$0.17 in 2010, compared to AU$0.74 last year. This works out to be a compound annual growth rate (CAGR) of approximately 16% a year over that time. The dividends haven't grown at precisely 16% every year, but this is a useful way to average out the historical rate of growth.
So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.
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. McMillan Shakespeare's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Still, the company has struggled to grow its EPS, and currently pays out 96% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.
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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. In summary, McMillan Shakespeare 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 that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for McMillan Shakespeare for free with public analyst estimates for the company.
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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