Do Investors Have Good Reason To Be Wary Of Propel Funeral Partners Limited's (ASX:PFP) 4.1% Dividend Yield?

Could Propel Funeral Partners Limited (ASX:PFP) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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.

Propel Funeral Partners pays a 4.1% dividend yield, and has been paying dividends for the past two years. It's certainly an attractive yield, but readers are likely curious about its staying power. Some simple analysis can reduce the risk of holding Propel Funeral Partners for its dividend, and we'll focus on the most important aspects 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 104% of Propel Funeral Partners's profits were paid out as dividends in the last 12 months. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Propel Funeral Partners paid out 145% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given Propel Funeral Partners's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Is Propel Funeral Partners's Balance Sheet Risky?

As Propel Funeral Partners'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. Propel Funeral Partners has net debt of 2.68 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 9.66 times its interest expense appears reasonable for Propel Funeral Partners, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of Propel Funeral Partners's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was AU$0.064 in 2018, compared to AU$0.12 last year. This works out to be a compound annual growth rate (CAGR) of approximately 35% a year over that time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Propel Funeral Partners has grown its EPS 148% over the past 12 months. We're glad to see EPS up on last year, but we're conscious that growth rates typically slow as companies increase in size. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We'd be conscious of any extra risk added by this practice. We do note though, one year is too short a time to be drawing strong conclusions about a company's future prospects.

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. Propel Funeral Partners paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. In summary, Propel Funeral Partners 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.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. As an example, we've identified 3 warning signs for Propel Funeral Partners that you should be aware of before investing.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.