Is This Share’s Attractive 7.7% Dividend Yield Sustainable?

Credit: Ethan Lofton

A high dividend yield can be an attractive thing for investors. But it’d be a mistake if we invest by focusing only on a share’s yield.

That’s because that yield-figure gives us no information at all about what’s important here – the sustainability of the share’s dividend.

With this in mind, what should investors make of construction outfit BRC Asia Limited (SGX: B03)?

Based on its share price of S$0.17 at the moment and dividend of 1.3 Singapore cents for FY2014 (financial year ended 30 September 2014), the company, which specialises in the manufacture of prefabricated steel reinforcement for use in concrete, has an attractive dividend yield of 7.7%.

In contrast, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which mimics the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a yield of just 2.7% currently.

Beneath the hood of a sustainable dividend

The following are a few things I like to look at when I’m trying to find strong dividends:

  1. A company’s track record in growing and paying its dividend.

This is important for the insight it gives investors on management’s commitment to reward investors as the business grows.

  1. A company’s ability to grow its free cash flow over time and generate it in excess of the dividends paid.

Dividends are ultimately paid with the cash a company has and that cash can come from a few sources. A company can 1) take on debt, 2) issue new shares, 3) sell its assets, and/or 4) generate cash from its daily business operations.

There are always exceptions, but it’s generally more sustainable for a company to pay its dividends using the cash its businesses produce.

It thus follows that investors should be keeping an eye on a company’s free cash flow as it’s the cash flow from operations that’s left after the firm has spent the necessary capital needed to maintain its businesses in their current state.

  1. The strength of the company’s balance sheet.

A company with a weak balance sheet that’s laden with debt would find its dividend at risk of being cut or removed – either due to pressure from creditors or a simple lack of cash – even at the slightest hiccup in the fortunes of its business.

In contrast, a strong balance sheet that is flush with cash gives a company a thick and valuable buffer against tough times.

Pulling the threads together

The chart below shows how BRC Asia has fared against the three criteria over its past 10 financial years:

BRC Asia's historical financials

Source: S&P Capital IQ

For the timeframe under study, BRC Asia has managed to pay a dividend consistently in each financial year; in addition, the firm has even managed to grow its dividend from 0.5 cents per share for the year ended December 2004 to some 1.3 cents in FY2014.

But, there were wild swings in BRC Asia’s dividends in those 10 years we’re looking at. For instance, the construction outfit’s payouts had declined sharply from 1.1 cents in FY2010 to just 0.6 cents in FY2011 before recovering.

I trust it’s also obvious to see that BRC Asia has not been able to generate consistent free cash flow over the years, much less grow that financial metric.

Moving on to the firm’s balance sheet, the level of borrowings has also been higher than cash for the most part – that’s not exactly a sign of a strong balance sheet.

A Fool’s take

BRC Asia’s history of having paid out a dividend consistently over the past decade is a nice thing to have. But, there are also negatives to consider, such as the company’s wild swings in dividends, inability to consistently generate free cash flow, and weak balance sheet.

When we pull all these considerations together, it would seem that there’s a chance that BRC Asia’s current level of dividends may not be sustainable.

That being said, it’s important to note that this look at the company’s historical financials is certainly not a holistic examination of the overall picture. To get to a better conclusion on BRC Asia’s investing merits, we’d have to study the qualitative aspects of the company’s business and consider if better days are ahead.

An understanding of BRC Asia’s financial history is important and informative, but more work needs to be done beyond that.

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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 company mentioned.