Pan-United Corporation Ltd Has A Noteworthy Dividend Yield Of 5.1% Now – But Are Its Dividends Sustainable?

Investors who are out looking for high-yielding shares right now might just have their sights set on cement maker Pan-United Corporation Ltd (SGX: P52).

At its current share price of S$0.835, the company, which also produces ready-mixed concrete, has a noteworthy dividend yield of 5.1% thanks to its annual dividend of 4.25 Singapore cents per share in 2014.

Comparatively, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the fundamentals of Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a yield of just 2.65% at the moment.

But just because Pan-United has a high yield now does not mean that it’d make for a good income share. What’s more important here would be the firm’s ability to sustain (or even grow) its current level of dividends.

What goes into the makings of a sustainable dividend

Generally speaking, there are a few things I like to dig into when I’m out looking for companies that can maintain or improve their dividends over time:

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

This criterion’s importance lies in the insight it can give investors about management’s commitment to reward shareholders as the business grows.

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

Ultimately, a company pays its dividends with the cash it has and that cash can 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 activities.

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

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

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

When a company has a weak balance sheet that’s laden with debt, its dividends can be at risk of being reduced or removed – either due to pressure from creditors or from 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 an ability to tide over the inevitable tough times that rolls along every now and then.

Pulling it all together

The chart below shows how Pan-United has fared against the three criteria over the period stretching from 2004 to 2014:

Pan-United's historical financials

Source: S&P Capital IQ

It’s worth highlighting the company’s solid track record in having paid an annual dividend consistently over the period under study.

But, there are a few areas of concern for investors to note.

Firstly, Pan-United has not been able to grow its dividends and free cash flow over time. What’s more, the company’s free cash flow has also come in lower than its dividends for the most part.

Lastly, while Pan-United has had a decent balance sheet from 2004 to 2012 (its cash levels have more or less tracked its borrowings), there’s been a significant deterioration in 2013 and 2014; as you can tell from the chart, the company’s level of borrowings has spiked over that period.

Changes in a company’s level of borrowings must be placed into context. For instance, an increase in borrowings can be a good thing if the debt that’s raised is used to help grow the business in a sustainable manner. But, sharp jumps in debt do amplify the financial risks that are borne by the firm and its shareholders.

A Fool’s take

Pan-United’s track record in paying a dividend come rain or shine over the decade ended 2014 is worthy of a thumbs-up.

But, when other factors are pulled into play – such as the firm’s inability to grow its free cash flow and the sharp deterioration in its balance sheet – it would appear that there’s a chance that Pan-United may not be able to sustain its current level of dividends.

That being said, it’s important to note that this look at Pan-United’s historical financial picture is certainly not a holistic view of the entire situation. Investors should still dig into the qualitative aspects of the firm’s business and consider if brighter days are ahead.

A study of Pan-United’s financial history can be important and informative. But more work certainly needs to be done beyond that before any investing decision can be reached.

For more analyses on dividend investing and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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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.