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There’s More Than Meets the Eye with Steady Dividends

Ser Jing - There's More Than Meets the Eye With Steady Dividends (pic) It’s easy to understand the attractiveness of steady dividends to investors. Who wouldn’t want a fixed amount of secondary income that comes in like clock-work?

Also, there’s a school of thought among some investors that companies paying dividends are disciplined. That’s because these companies know they have to generate that cash to pay shareholders at the end of the day. So, it is likely that investors see steady dividends and assume it’s a bed of roses.

But things are never quite so simple.

It’s not a dividend when you’re burning cash

Let’s take NSL (SGX: N02) as an example, a company with interests in construction products, chemicals and oil & chemical waste management. Its annual dividend for 2012 was S$0.10 per share -unchanged since 2009 – thus giving its shares a dividend yield of 7% at the current price of $1.42. That’s an attractive dividend, given that the average yield in the market, represented by the Straits Times Index (SGX: ^STI), currently stands at around 2.5%.

So, here we have a share that seemingly has a few good things going for it; a high dividend yield; a short history of steady dividends over four years; and a strong balance sheet carrying S$156.1m in cash and only S$31.1m in debt as of the first quarter of 2013.

But, a different picture emerges when we study the company’s cash flow situation. From the table below, we can see that NSL could not generate sufficient free cash flow from its business operations to cover its dividend payments in four out of five years between 2008 and 2012. In fact, dividend payments have dwarfed the company’s free cash flows over those five years.

 NSL

2008

2009

2010

2011

2012

Total

Free Cash Flow, S$m

17.2

66.4

33.2

50.2

8.5

175.4

Dividends, S$m

74.7

74.7

37.4

37.4

37.4

261.5

The difference is stark when we contrast NSL’s cash flows with that of Starhub’s (SGX: CC3), a telecommunications operator with a steady S$0.20 per share in annual dividends from 2010 to 2012. The table below shows how Starhub could easily cover its dividend payments with its free cash flow over the same five year period.

 Starhub

2008

2009

2010

2011

2012

Total

Free Cash Flow, S$m

377.7

461

397.5

449.7

416.8

2102.7

Dividends, S$m

308

317

343

343

343

1654.2

Ultimately, dividends are paid in cash. When a business can’t fund those dividends from cash flow generated by its daily operations, they have to turn to other sources, putting the sustainability of those dividends at risk, as in NSL’s case.

What about the cash in the bank?

One might argue that NSL’s strong balance sheet gives it major lee-way in turning its cash-flow situation around. But as it turns out, the company’s balance sheet has steadily grown weaker over the years, judging by consistently declining net-cash levels (defined as Cash minus Debt) since 2007.

NSL

2007

2008

2009

2010

2011

2012

Cash, S$m

233.3

203.1

161.4

158.6

150.5

146.1

Debt, S$m

40.7

47.2

29.4

25.5

19.9

23.2

Net Cash, S$m

192.6

155.9

132.0

133.1

130.6

122.9

Saddled with the burden of paying dividends without sufficient cash flows and yet needing money to fund daily transactions and long-term expansion activities, NSL has had to dip into its cash hoard to meet those demands. The company’s act of dipping into the cookie jar can’t go on indefinitely and once again brings up the risk of dividend-sustainability.

Once again, we can contrast NSL with Starhub, which has been able to strengthen its balance sheet – as evidenced by the negative, but improving net-cash position – over the years with the left-over cash that was not returned to shareholders as dividends.

Starhub

2007

2008

2009

2010

2011

2012

Cash, S$m

138

128.3

234.2

237.5

179.2

312

Debt, S$m

968

913.7

895.8

805.4

662.5

687.5

Net Cash, S$m

-830

-785.4

-661.6

-567.9

-483.3

-375.5

Foolish Bottom Line

Steady dividends from a company can be a good sign. But, those dividends alone can’t tell an investor much about its reliability or sustainability. Ultimate, investors have to pay attention to a company’s cash flows.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.