Downer EDI Limited (ASX:DOW) has announced that on 21st of September, it will be paying a dividend ofA$0.08, which a reduction from last year's comparable dividend. The dividend yield of 3.1% is still a nice boost to shareholder returns, despite the cut.

See our latest analysis for Downer EDI

Downer EDI's Payment Has Solid Earnings Coverage

A big dividend yield for a few years doesn't mean much if it can't be sustained. Downer EDI is unprofitable despite paying a dividend, and it is paying out 158% of its free cash flow. These payout levels would generally be quite difficult to keep up.

According to analysts, EPS should be several times higher next year. If the dividend continues along recent trends, we estimate the payout ratio will be 14%, so there isn't too much pressure on the dividend. historic-dividend

Dividend Volatility

While the company has been paying a dividend for a long time, it has cut the dividend at least once in the last 10 years. Since 2013, the annual payment back then was A$0.20, compared to the most recent full-year payment of A$0.13. This works out to be a decline of approximately 4.2% per year over that time. A company that decreases its dividend over time generally isn't what we are looking for.

Dividend Growth Potential Is Shaky

With a relatively unstable dividend, it's even more important to evaluate if earnings per share is growing, which could point to a growing dividend in the future. Downer EDI's EPS has fallen by approximately 28% per year during the past five years. A sharp decline in earnings per share is not great from from a dividend perspective. Even conservative payout ratios can come under pressure if earnings fall far enough. Over the next year, however, earnings are actually predicted to rise, but we would still be cautious until a track record of earnings growth can be built.

We're Not Big Fans Of Downer EDI's Dividend

In summary, it's not great to see that the dividend is being cut, but it is probably understandable given that the current payment level was quite high. The company seems to be stretching itself a bit to make such big payments, but it doesn't appear they can be consistent over time. The dividend doesn't inspire confidence that it will provide solid income in the future.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've picked out 1 warning sign for Downer EDI that investors should know about before committing capital to this stock. If you are a dividend investor, you might also want to look at our curated list of high yield dividend stocks.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.