Would Fairchem Speciality Limited (NSE:FAIRCHEM) Be Valuable To Income Investors?
Simply Wall St
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Today we'll take a closer look at Fairchem Speciality Limited (NSE:FAIRCHEM) 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. 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 a 0.5% yield and a eight-year payment history, investors probably think Fairchem Speciality looks like a reliable dividend stock. While the yield may not look too great, the relatively long payment history is interesting. Some simple analysis can reduce the risk of holding Fairchem Speciality for its dividend, and we'll focus on the most important aspects below.
NSEI:FAIRCHEM Historical Dividend Yield, July 15th 2019
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. Fairchem Speciality paid out 10% of its profit as dividends, over the trailing twelve month period. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Unfortunately, while Fairchem Speciality pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is Fairchem Speciality's Balance Sheet Risky?
As Fairchem Speciality 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. With net debt of 2.16 times its EBITDA, Fairchem Speciality's debt burden is within a normal range for most listed 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. Net interest cover of 6.13 times its interest expense appears reasonable for Fairchem Speciality, although we're conscious that even high interest cover doesn't make a company bulletproof.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The first recorded dividend for Fairchem Speciality, in the last decade, was eight years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we're cautious about the consistency of its dividend across a full economic cycle. During the past eight-year period, the first annual payment was ₹0.69 in 2011, compared to ₹2.50 last year. This works out to be a compound annual growth rate (CAGR) of approximately 17% a year over that 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 not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? It's good to see Fairchem Speciality has been growing its earnings per share at 12% a year over the past 5 years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.
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. Fairchem Speciality has a low payout ratio, which we like, although it paid out virtually all of its generated cash. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In sum, we find it hard to get excited about Fairchem Speciality 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.
See if management have their own wealth at stake, by checking insider shareholdings in Fairchem Speciality stock.
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.
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. Thank you for reading.
