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Is Archrock, Inc. (NYSE:AROC) A Strong Dividend Stock?

Is Archrock, Inc. (NYSE:AROC) 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.

In this case, Archrock likely looks attractive to dividend investors, given its 6.6% dividend yield and six-year payment history. It sure looks interesting on these metrics - but there's always more to the story . Some simple analysis can reduce the risk of holding Archrock for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Archrock!

NYSE:AROC Historical Dividend Yield, January 25th 2020
NYSE:AROC Historical Dividend Yield, January 25th 2020

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. In the last year, Archrock paid out 115% of its profit as dividends. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, Archrock paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Archrock's Balance Sheet Risky?

As Archrock's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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). With net debt of 4.81 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.97 times its interest expense, Archrock's interest cover is starting to look a bit thin.

Consider getting our latest analysis on Archrock's financial position here.

Dividend Volatility

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. Archrock has been paying a dividend for the past six years. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past six-year period, the first annual payment was US$0.60 in 2014, compared to US$0.58 last year. Dividend payments have shrunk at a rate of less than 1% per annum over this time frame.

We struggle to make a case for buying Archrock for its dividend, given that payments have shrunk over the past six years.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Archrock has grown its earnings per share at 40% per annum over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in 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.

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. We're a bit uncomfortable with Archrock paying out a high percentage of both its cashflow and earnings. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. With this information in mind, we think Archrock may not be an ideal dividend stock.

See if management have their own wealth at stake, by checking insider shareholdings in Archrock stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.