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Why I think G8 Education Ltd will probably cut its dividend again

Should you buy G8 Education Ltd (ASX: GEM) for its 7.1% dividend, and is that dividend sustainable? High dividends can often be a sign that a dividend is at risk, with the old adage being “the closer it gets to 10%, the closer it gets to zero.”

Indeed, G8 has already cut its dividend, moving from 6 cents a quarter in 2016 (24 cents p.a.) to 10 cents per half in the second half of 2017 (i.e., 20 cents p.a.). Can this reduced dividend be maintained?

At first glance it appears not, since earnings per share were 18.92 cents, which is less than the implied annual dividend of 20 cents.

However, on an underlying basis, (excluding acquisition related expenses, write off of borrowing costs, foreign currency translation loss and other items), earnings per share were 21.8 cents, which is more than the dividend.

With that said, one-off costs such as acquisition costs are a normal part of G8’s business, which means that it is unlikely to earn the full underlying earnings per share figure on a cash basis. As a result, I think that a 20 cent dividend is likely unsustainable without an improvement in earnings.

There is also another way to gauge the affordability of a dividend, and that is via cash flows. Dividends of 20 cents per share multiplied by 448.5 million shares on issue (as of the latest Appendix 3B) will cost approximately $89.7 million per year.

In the 2017 financial year, G8 generated $92 million in cash flow from operations, and spent a combined ~$86 million on acquiring new businesses ($67 million) and reinvesting in current businesses ($19 million).

If it earns $92 million in cash flow from operations and pays $89.7 million in dividends, G8 a) has no wiggle room, b) won’t be able to grow earnings by buying new centres, and c) won’t be able to reinvest in current centres, unless it continues to take on more debt.

As a result, I think that G8’s 20 cent dividend is likely unsustainable.

On the other hand, even without acquisitions of new centres, G8’s earnings are expected to improve this year because of cost savings, recent reinvestment in centres (which should lift occupancy) and an increase to government subsidies for the childcare industry. Thomson Reuters analysts’ estimates forecast G8 to earn 23.6 cents per share this year, which could mean the dividend is affordable.

Even so, business is competitive, G8’s performance has been declining in recent years, and a 20 cent dividend would likely reflect most or all of G8’s profit this year. As a result I think there’s a good chance G8 will have to reduce its dividend again in the future.

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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia has recommended G8 Education Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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