Are Dividend Investors Getting More Than They Bargained For With LEM Holding SA's (VTX:LEHN) Dividend?

Simply Wall St

Could LEM Holding SA (VTX:LEHN) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

A high yield and a long history of paying dividends is an appealing combination for LEM Holding. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

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SWX:LEHN Historical Dividend Yield, November 13th 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. LEM Holding paid out 95% of its profit as dividends, over the trailing twelve month period. With a payout ratio this high, we'd say its dividend is not well covered by earnings. This may be fine if earnings are growing, but it might not take much of a downturn for the dividend to come under pressure.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. LEM Holding paid out 101% of its free cash flow last year, which we think is concerning if cash flows do not improve. Cash is slightly more important than profit from a dividend perspective, but given LEM Holding's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Is LEM Holding's Balance Sheet Risky?

As LEM Holding's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 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). LEM Holding has net debt of 0.32 times its EBITDA, which we think is not too troublesome.

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 371.97 times its interest expense, LEM Holding's interest cover is quite strong - more than enough to cover the interest expense.

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

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. LEM Holding has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was CHF10.00 in 2009, compared to CHF42.00 last year. Dividends per share have grown at approximately 15% per year over this time. The dividends haven't grown at precisely 15% 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

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? While there may be fluctuations in the past , LEM Holding's earnings per share have basically not grown from where they were five years ago. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. This level of earnings growth is low, and the company is paying out 95% of its profit. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

Conclusion

To summarise, shareholders should always check that LEM Holding's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. In this analysis, LEM Holding doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 3 LEM Holding analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.