How Does Algonquin Power & Utilities Corp. (TSE:AQN) Fare As A Dividend Stock?

Dividend paying stocks like Algonquin Power & Utilities Corp. (TSE:AQN) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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.

A high yield and a long history of paying dividends is an appealing combination for Algonquin Power & Utilities. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding Algonquin Power & Utilities for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Algonquin Power & Utilities!

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. 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. Algonquin Power & Utilities paid out 53% of its profit as dividends, over the trailing twelve month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Algonquin Power & Utilities paid out 685% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Algonquin Power & Utilities's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Algonquin Power & Utilities to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is Algonquin Power & Utilities's Balance Sheet Risky?

As Algonquin Power & Utilities has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 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 6.22 times its EBITDA, Algonquin Power & Utilities could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 1.94 times its interest expense is starting to become a concern for Algonquin Power & Utilities, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

Consider getting our latest analysis on Algonquin Power & Utilities's financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Algonquin Power & Utilities's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was US$0.19 in 2010, compared to US$0.56 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% a year over that time. The dividends haven't grown at precisely 11% every year, but this is a useful way to average out the historical rate of growth.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

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. It's good to see Algonquin Power & Utilities has been growing its earnings per share at 41% a year over the past five years. With recent, rapid earnings per share growth and a payout ratio of 53%, this business looks like an interesting prospect if earnings are reinvested effectively.

We'd also point out that Algonquin Power & Utilities issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

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. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Algonquin Power & Utilities out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. However, there are other things to consider for investors when analysing stock performance. To that end, Algonquin Power & Utilities has 7 warning signs (and 2 which can't be ignored) we think you should know about.

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.