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Does InvoCare Limited (ASX:IVC) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Is InvoCare Limited (ASX:IVC) 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 stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A 2.7% yield is nothing to get excited about, but investors probably think the long payment history suggests InvoCare has some staying power. Some simple analysis can reduce the risk of holding InvoCare for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on InvoCare!

ASX:IVC Historical Dividend Yield, January 16th 2020

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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 67% of InvoCare's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend 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. Last year, InvoCare paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is InvoCare's Balance Sheet Risky?

As InvoCare has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). InvoCare has net debt of 2.95 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 4.64 times its interest expense, InvoCare's interest cover is starting to look a bit thin.

Consider getting our latest analysis on InvoCare'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. InvoCare 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 cut on at least one occasion historically. During the past ten-year period, the first annual payment was AU$0.23 in 2010, compared to AU$0.37 last year. Dividends per share have grown at approximately 4.6% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

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 4.4% a year for the past five years, which is better than seeing them shrink! Growth of 4.4% is relatively anaemic growth, which we wonder about. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.

We'd also point out that InvoCare issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. InvoCare 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. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Overall, InvoCare 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 that are growing earnings tend to be the best dividend stocks over the long term. See what the 8 analysts we track are forecasting for InvoCare for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.

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.