Dividend paying stocks like Sembcorp Industries Ltd (SGX:U96) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A 1.8% yield is nothing to get excited about, but investors probably think the long payment history suggests Sembcorp Industries has some staying power. Some simple research can reduce the risk of buying Sembcorp Industries for its dividend - read on to learn more.
SGX:U96 Historical Dividend Yield, August 11th 2019
Payout ratios
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Looking at the data, we can see that 22% of Sembcorp Industries's profits were paid out as dividends in the last 12 months. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Sembcorp Industries pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is Sembcorp Industries's Balance Sheet Risky?
As Sembcorp Industries 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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 6.93 times its EBITDA, Sembcorp Industries could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.44 times its interest expense, Sembcorp Industries's interest cover is starting to look a bit thin. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.
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. Sembcorp Industries has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was S$0.11 in 2009, compared to S$0.04 last year. The dividend has shrunk at around 9.6% a year during that period. Sembcorp Industries's dividend has been cut sharply at least once, so it hasn't fallen by 9.6% every year, but this is a decent approximation of the long term change.
We struggle to make a case for buying Sembcorp Industries for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Sembcorp Industries's EPS have fallen by approximately 17% per year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Sembcorp Industries's earnings per share, which support the dividend, have been anything but stable.
Conclusion
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. First, we like Sembcorp Industries's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Overall, Sembcorp Industries falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 13 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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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.
