Altagas Ltd. (TSX:ALA) currently pays its investors a yield of 7.4% in monthly installments. Investors normally get concerned with dividend stocks that pay more than 5% of their stock price, as it raises concerns that the payout might be too high and could see a reduction in the future.
However, that’s not always the case, and investors should do their own due diligence when looking at stocks to evaluate why a share has a high yield and whether or not it can continue. A high yield could be due to the company following a high payout ratio, or it could simply be that the share price has declined recently, resulting in a higher yield.
The share price has declined 12% year to date
One reason the dividend for Altagas is so high is because of the stock’s disappointing performance in 2017. If not for the drop in price, the share price would be closer to $35 and the yield would be much closer to 6%.
The stock can drop for numerous reasons, none of which necessarily have to do performance, which can be especially true in oil and gas, where the underlying commodity price can have a big impact on a company. For that reason, it’s important next to look at the sustainability of the dividend based on the company’s recent performance.
Can the company maintain its current dividend?
There are two common ways that you can evaluate a company’s ability to pay its dividends: one is by looking at its per-share earnings, and the other by its cash flow.
Payout ratio using earnings
In the trailing 12 months, the company’s earnings per share have totaled $0.47. Altagas currently pays $0.1825 every month in dividends per stock, meaning that at an annual dividend of $2.19, the company is paying out 466% of its earnings. This is clearly a very troubling payout ratio and should raise alarm bells for investors.
The one problem with this approach is that earnings include non-cash items that have no impact on a company’s ability to pay cash dividends. For this reason, I’ll look at the second method in evaluating a company’s payouts: the cash flow method.
Payout ratio using free cash
Free cash is what a company has left over from its operating activities and capital expenditures. The company can issue what’s “free” as dividends, or simply accumulate the cash for a number of different reasons.
In the last four quarters, Altagas has accumulated free cash of just $42 million, well below the $411 million that it paid out in dividends during that time. This could suggest that a problem does exist, given that the company’s payout ratio under either method shows that Altagas has been paying out a lot more than it can afford.
Does this mean Altagas could see a cut in its dividend?
Just looking at the number, unfortunately, won’t tell you the whole story. In fact, Altagas recently hiked its dividend, suggesting the company is not concerned with the level of its payouts.
Altagas is in the middle of acquiring WGL Holdings Inc, which has weighed down its available cash, but it also expects the acquisition will help further grow its dividend. Altagas is an exception to the rules here, and although the payout ratio is certainly high, investors shouldn’t be concerned about a dividend cut anytime soon.
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Fool contributor David Jagielski owns shares of Altagas Ltd. Altagas is a recommendation of Stock Advisor Canada.