This Low-Yielding Share Might Just Turn Out To Be a Great Dividend Play

When it comes to picking dividend shares, pan-Asian retailer Dairy Farm International Holdings Ltd (SGX: D01) would likely not be on the radar for most given its low dividend yield. At its current price of US$9.30 per share, the company’s fetching a historical yield of 2.47% based on its dividend for 2013.

In contrast, the SPDR STI ETF (SGX: ES3) has a yield of 2.6% at the moment; the exchange-traded fund mimics the fundamentals of Singapore’s share market benchmark, the Straits Times Index (SGX: ^STII).

Yet, a deeper dive into Dairy Farm suggests that the company might still become a great dividend play despite its currently low yield, . When it comes to separating the wheat from the chaff for dividend shares, the following signs can help:

  1. A company’s track record in growing its dividend. This is important as it gives investors insight on how committed management is in rewarding shareholders as a company grows.
  2. A company’s ability to grow its free cash flow and generate free cash flow in excess of dividends paid. Dividends are ultimately paid out through the cash that a company has. Although a firm can borrow or issue shares to raise the cash needed to pay dividends, it’s generally more sustainable for a company to pay its dividends using the cash generated from its daily business operations. So, investors should watch the free cash flow metric as it measures the cash that’s generated after the company has made the necessary reinvestments to maintain its businesses at their current state.
  3. The strength of the company’s balance sheet. Companies with weak balance sheets (those that are bloated with debt) run much higher risks of having to cut their dividends when their businesses slow down temporarily. In this sense, having a strong balance sheet gives a company the resources that are needed to tide over tough times.

The following chart shows how Dairy Farm has fared on those three fronts.

Dairy Farm's dividends and balance sheet data

Source: S&P Capital IQ

A quick glance at the chart above shows two bright spots with Dairy Farm’s financials: 1) the retailer’s balance sheet has improved tremendously since 2009 with its cash position climbing even as its borrowings decrease; 2) the company has also been able to generate consistently positive free cash flow which has shown a general upward-trend.

Dairy Farm’s track record with its dividends might be where some investors have concern. On the surface, the company’s dividends have been somewhat erratic and actually seemed to have decreased from US$0.346 per share in 2003 to US$0.23 in 2013.

Turns out, Dairy Farm had paid significant special dividends in 2003, 2004, and 2007. If those were stripped away, Dairy Farm’s regular dividend had actually grown by a compounded annual rate of 18% from US$0.046 per share in 2003; the increase in regular dividends have also been very consistent as seen in the chart below.

Dairy Farm's dividends

Source: S&P Capital IQ

With the growth in regular dividends that Dairy Farm has had, investors who bought the retailer’s shares back at the start of 2003 would be enjoying a massive yield-on-cost of 24% now based on the firm’s dividends for 2013.

A Fool’s take

Although Dairy Farm has a low yield currently, it has had a track record of stellar dividend growth in addition to having other strong financial characteristics. This is why I mentioned earlier that the retailer might still be an attractive income share.

That said, it’s worth noting that a study of Dairy Farm’s finances alone can’t give us the full picture. We’d still have to consider the future of the company’s business in addition to the risks that it faces. And for that, you can turn to The Motley Fool Singapore’s latest Tug of Fools series on Dairy Farm. The Tug of Fools sees two opposing analysts, one from the Fool and the other from Shares Investment, put forward their best arguments about a share.

All told, investors would have to weigh the risks and rewards with Dairy Farm in order to come up with an intelligent investing decision.

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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 writer Chong Ser Jing doesn’t own shares in any companies mentioned.