Should Sydney Airport Limited (ASX:SYD) Be Part Of Your Income Portfolio?

Simply Wall St

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Could Sydney Airport Limited (ASX:SYD) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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.

A high yield and a long history of paying dividends is an appealing combination for Sydney Airport. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding Sydney Airport for its dividend, and we'll focus on the most important aspects below.

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ASX:SYD Historical Dividend Yield, July 19th 2019

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Sydney Airport paid out 227% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Sydney Airport paid out 99% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. As Sydney Airport's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Is Sydney Airport's Balance Sheet Risky?

As Sydney Airport'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 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. Sydney Airport has net debt of 7.76 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.17 times its interest expense is starting to become a concern for Sydney Airport, 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.

Remember, you can always get a snapshot of Sydney Airport's latest financial position, by checking our visualisation of its financial health.

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. For the purpose of this article, we only scrutinise the last decade of Sydney Airport's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was AU$0.27 in 2009, compared to AU$0.39 last year. Dividends per share have grown at approximately 3.7% per year over this time. Sydney Airport's dividend payments have fluctuated, so it hasn't grown 3.7% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

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 Sydney Airport has been growing its earnings per share at 40% a year over the past 5 years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet.

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. Sydney Airport paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. 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 summary, Sydney Airport has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 10 Sydney Airport analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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.