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Today we'll take a closer look at HK Electric Investments and HK Electric Investments Limited (HKG:2638) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if HK Electric Investments and HK Electric Investments is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story . When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
SEHK:2638 Historical Dividend Yield, July 10th 2019
Payout ratios
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, HK Electric Investments and HK Electric Investments paid out 116% of its profit as dividends. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. HK Electric Investments and HK Electric Investments paid out 240% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given HK Electric Investments and HK Electric Investments's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.
Is HK Electric Investments and HK Electric Investments's Balance Sheet Risky?
As HK Electric Investments and HK Electric Investments has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. HK Electric Investments and HK Electric Investments has net debt of 5.02 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. HK Electric Investments and HK Electric Investments has EBIT of 5.32 times its interest expense, which we think is adequate. Despite a decent level of interest cover, shareholders should remain cautious about the high level of net debt. Rising rates or tighter debt markets have a nasty habit of making fools of highly-indebted dividend stocks.
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. HK Electric Investments and HK Electric Investments has been paying a dividend for the past five years. During the past five-year period, the first annual payment was HK$0.33 in 2014, compared to HK$0.40 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.9% a year over that time.
It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.
Dividend Growth Potential
Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Over the past five years, it looks as though HK Electric Investments and HK Electric Investments's EPS have declined at around 10% a year. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.
Conclusion
To summarise, shareholders should always check that HK Electric Investments and HK Electric Investments's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. Using these criteria, HK Electric Investments and HK Electric Investments looks quite suboptimal from a dividend investment perspective.
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 8 analysts are forecasting a turnaround in our free collection of analyst estimates here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.
