Why National Grid’s 6.01% dividend payment could be in trouble

Dividend cuts are almost always preceded or succeeded by a painful decline in share price - so understanding how to screen out companies whose dividend payments are at risk can help improve portfolio performance.

There are lots of financial indicators that can help us evaluate the sustainability of a company’s dividend. Taking the best of these and applying them to National Grid (LON:NG.), which pays a 0.47 rolling dividend, shows that shareholders ought to be seriously concerned about the sustainability of its dividend...

Is National Grid’s dividend cover below 1.0x?

Dividend cover is seen by many as the essential dividend health metric and is calculated by dividing earnings per share divided by dividend per share (EPS/DPS). The usual rule of thumb is that dividend cover of less than 1.5x earnings can become a concern.

• The rolling dividend cover is based on projected dividends and earnings. National Grid’s rolling dividend cover is 1.38.
• The historic dividend cover is, of course, based on historic dividends and earnings. National Grid’s historic dividend cover is 0.93.

Historic cover is below the 1.0x safety threshold for National Grid that we have set. While the rolling cover is better, at 1.38, it is still below the 1.5 times figure most investors are comfortable with.

Does National Grid have a strong balance sheet?

An alternative way to analyse dividend safety is to focus more directly on a company’s balance sheet strength. A highly leveraged company that struggles to meet its short-term liabilities is more likely to cut its dividend than a well-financed one.

A safe level of net gearing (net debt to equity) on the balance sheet is generally considered to be 50 percent or less. National Grid’s net gearing ratio is 136.9% - above the 50% threshold.

The current ratio (current assets / current liabilities ) gauges a company’s capacity to service short term debts. A current ratio of less than one can be cause for concern. National Grid’s current ratio is 0.87 - below the 1.0x threshold.

Does National Grid have enough cash?

Shareholders could take additional steps to analyse dividend safety by comparing Free Cashflows Per Share (FCF PS) with the Dividend Per Share (DPS). National Grid generated 11p in FCF PS. This is lower than the dividend payout 47p and indicates that the company has not generated enough FCF to cover dividends over the past twelve months.

Income investing: what you need to know

For many investors, dividends are a vital part of their long-term strategy. That's why we have created a variety of income-focused stock screens, such as the Best Dividends Screen, to identify promising candidates for income portfolios. Take a look and see if any of the qualifying stocks might be worthy of further research.

If you’d like to discover more about dividend investing, you can read our free ebook: How to Make Money in Dividend Stocks.