Dividend yields are often credited with providing a floor under a share price and reducing its volatility - but when those dividends get cut, the implications for shareholders are painful.
Thankfully there are some warning signs that point to an upcoming dividend cut and allow us as investors to get out ahead of time. Going through these measures and applying them to Restaurant (LON:RTN), which pays a 0.021 rolling dividend, shows that shareholders ought to be seriously concerned about the sustainability of its dividend...
Evaluating Restaurant (LON:RTN)'s balance sheet strength
A leveraged company with high levels of debt to equity that struggles to meet its short-term liabilities is more likely to cut its dividend than a well-financed one. A safe level of net gearing (net debt to equity) on the balance sheet is generally considered to be 50 percent or less. Restaurant’s net gearing ratio is 70.7% - above the 50% threshold.
The current ratio (current assets / current liabilities ) is another balance sheet ratio that focuses more on a company’s capacity to service short term debts. A current ratio of less than one can be cause for concern, but here we set the limit at less than 1.0x. Restaurant’s current ratio is 0.50.
Does Restaurant generate enough cash?
A dividend-paying stock is often regarded as having a certain level of quality because it is assumed to generate adequate cash from operations to pay said dividend. This is not always the case though - companies that feel compelled to pay a dividend they can no longer afford often increase net debt and use cash sub-optimally just to avoid a dividend cut.
Shareholders can check if this might be the case by comparing Free Cashflows Per Share (FCF PS) with the Dividend Per Share (DPS). Restaurant generated -0.009 in FCF PS. This is lower than the dividend payout 0.021 and indicates that the company has not generated enough FCF to cover dividends over the past twelve months.
A look at Restaurant (LON:RTN)’s dividend cover
Dividend cover is perhaps the most widely interpreted dividend health metric. It is computed by dividing earnings per share divided by dividend per share (EPS/DPS) and, generally speaking, dividend cover of less than 1.5x earnings should be a flag for further investigation.
- The rolling dividend cover for Restaurant, based on projected dividends and earnings, is 5.43.
- The historic dividend cover is based on historic dividends and earnings. Restaurant’s historic dividend cover is -3.92.
Both of these figures are below the 1.0x safety threshold for Restaurant that we have set. This suggests that the dividend could be at risk.
Income investing: what you need to know
For many investors, dividends are a vital part of their long-term strategy. That's why we have created a variety of income-focused stock screens, such as the Best Dividends Screen, to identify promising candidates for income portfolios. Take a look and see if any of the qualifying stocks might be worthy of further research.
As for Restaurant (LON:RTN), you can find a wealth of financial data on the group's StockReport, including information on the group's past and forecast dividend payments. If you’d like to discover more about dividend investing, you can read our free ebook: How to Make Money in Dividend Stocks.