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Today we'll take a closer look at TI Fluid Systems plc (LON:TIFS) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
Some readers mightn't know much about TI Fluid Systems's 5.6% dividend, as it has only been paying distributions for a year or so. Some simple analysis can reduce the risk of holding TI Fluid Systems for its dividend, and we'll focus on the most important aspects below.
LSE:TIFS 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. 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 34% of TI Fluid Systems's profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. TI Fluid Systems's cash payout ratio last year was 15%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that TI Fluid Systems'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 TI Fluid Systems's Balance Sheet Risky?
As TI Fluid Systems 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. TI Fluid Systems has net debt of 2.05 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. With EBIT of 4.85 times its interest expense, TI Fluid Systems's interest cover is starting to look a bit thin.
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. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. During the past one-year period, the first annual payment was €0.013 in 2018, compared to €0.12 last year. Last year's dividends were more than 600% higher than the payment one years ago.
TI Fluid Systems has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. TI Fluid Systems has grown its EPS 16% over the past 12 months. It's good to see earnings per share rising, but one year is too short a period to get excited about. Were this trend to continue, we'd be interested. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested. Any one year of performance can be misleading for a variety of reasons, so we wouldn't like to form any strong conclusions based on these numbers alone.
We'd also point out that TI Fluid Systems 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
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. It's great to see that TI Fluid Systems is paying out a low percentage of its earnings and cash flow. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. TI Fluid Systems performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for TI Fluid Systems for free with public analyst estimates for the company.
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.
