Is Hera S.p.A. (BIT:HER) A Smart Pick For Income Investors?

Dividend paying stocks like Hera S.p.A. (BIT:HER) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

While Hera's 2.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can reduce the risk of holding Hera for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Hera!

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. In the last year, Hera paid out 48% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Hera paid out 56% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Hera's Balance Sheet Risky?

As Hera has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 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. Hera has net debt of 3.00 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 6.86 times its interest expense appears reasonable for Hera, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Hera'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. Hera has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was €0.08 in 2009, compared to €0.10 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.3% a year over that time.

Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Hera has grown its earnings per share at 11% per annum over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

Conclusion

To summarise, shareholders should always check that Hera's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Hera pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Overall we think Hera scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for Hera for free with public 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.