Online pet pharmacy PetMed Express (PETS -1.90%) pays a relatively high dividend yield in the stock market today. At 4.5%, that's significantly more than what the average stock on the S&P 500 pays -- just 1.3%. The danger with high-yielding stocks can sometimes be that their payouts don't last, especially if their financials can't support them.
Is PetMed's bottom line and free cash flow strong enough to sustain its current payout, or should income investors be swapping out this investment for a safer dividend stock to hold in their portfolios?
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The company's payout ratio is over 100%
PetMed reported its latest quarterly results in January. For the past three months of 2021, its sales totaled $60.7 million and were down 8% year over year. Rising operating expenses compounded the problem and led to the company's net income falling from $7.6 million a year ago to just $4.3 million in the fourth quarter. On a per-share basis, PetMed's profit was $0.21 -- below its current quarterly dividend payment of $0.30.
As investors will note from the chart below, a high payout ratio (over 80%) hasn't been unusual for the company. But at 110%, this is definitely a high in recent years:
PETS Payout Ratio data by YCharts
However, I'm always cautious not to assess the strength of a dividend on profitability alone. Non-cash expenses such as depreciation can make the ratio look worse, even though it doesn't affect the ability of the business to make cash payments. And that's why it's always helpful to use the statement of cash flow for some additional context.
Free cash has been inconsistent in recent years
In the past year, PetMed has generated $26 million in free cash flow. During that time, it has paid out $24 million in dividends. So at first glance, it looks as though the business is in good enough shape to continue making its dividend payments. However, it hasn't been a linear path. On a quarterly basis, PetMed has often jumped between not having enough free cash and having more than enough. In Q4, there was a modest buffer of over $2 million, but it hasn't been uncommon for the difference between free cash flow and dividends paid to be negative, which would suggest the payout may not be sustainable.
Fundamental Chart data by YCharts
PetMed's financials aren't overly strong enough to suggest that they can definitely support these payouts. Adding some historical context here can be helpful to see if the yield itself is abnormally high and where management may see justification in reducing its quarterly payments.
The yield is in line with historical averages
PetMed has been paying a dividend for more than a decade, and at 4.3%, the current yield is not much higher than its average.
PETS Dividend Yield data by YCharts
This doesn't mean the company won't make a cut. But it would certainly be easier to justify slashing the dividend if it was near its high of more than 7% vs. now, when it's close to its long-term average of 4%.
Should investors be worried?
PetMed's dividend isn't one that I would feel comfortable relying on as an investor. Although the payout is sustainable when looking at the company's cash flow, there's not much of a buffer there, especially if the business decides to deploy more money toward expansion efforts.
With many other, safer dividend stocks to choose, investors are better off looking elsewhere. Rising inflation and labor costs could make turning a profit and generating strong free cash flow even more difficult for PetMed this year, perhaps forcing management to cut the dividend even if it doesn't want to do so.
