Dividend paying stocks like Bonterra Energy Corp. (TSE:BNE) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
With Bonterra Energy yielding 6.3% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. Remember though, given the recent drop in its share price, Bonterra Energy's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. There are a few simple ways to reduce the risks of buying Bonterra Energy for its dividend, and we'll go through these below.
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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. Looking at the data, we can see that 57% of Bonterra Energy'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. Of the free cash flow it generated last year, Bonterra Energy paid out 36% as dividends, suggesting the dividend is affordable. It's positive to see that Bonterra Energy'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.
Is Bonterra Energy's Balance Sheet Risky?
As Bonterra Energy 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. Bonterra Energy is carrying net debt of 3.16 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. With EBIT of less than 1 times its interest expense, Bonterra Energy's financial situation is potentially quite concerning. Readers should investigate whether it might be at risk of breaching the minimum requirements on its loans.
Consider getting our latest analysis on Bonterra Energy's financial position 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. For the purpose of this article, we only scrutinise the last decade of Bonterra Energy's dividend payments. This company's dividend has not fluctuated wildly, but its dividend per share payments have still decreased substantially over this time, which is not ideal. During the past ten-year period, the first annual payment was CA$1.44 in 2010, compared to CA$0.12 last year. The dividend has fallen 92% over that period.
We struggle to make a case for buying Bonterra Energy for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Bonterra Energy's earnings per share have shrunk at 29% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Bonterra Energy's earnings per share, which support the dividend, have been anything but stable.
We'd also point out that Bonterra Energy 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
To summarise, shareholders should always check that Bonterra Energy's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Bonterra Energy has an acceptable payout ratio and its dividend is well covered by cashflow. It's not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. In sum, we find it hard to get excited about Bonterra Energy 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.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 4 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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.
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. Thank you for reading.
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