Can This 4.7% Yield Give You Consistent Dividends?

New Toyo International Holdings Ltd (SGX: N08) may not have an exciting business – the company manufactures packaging materials and products – but it does have a dividend yield that may send dividend investors’ pulses racing.

At its current share price of S$0.255, New Toyo has a dividend yield of 4.7% thanks to its annual dividend of S$0.012 per share in 2014.

In comparison, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a yield of just 2.6% at the moment.

But, New Toyo’s attractive yield does not automatically mean that it can be a good income share. What’s more important here is the company’s ability to deliver consistent – or even better, growing – dividends.

The anatomy of a sustainable dividend

Generally speaking, there are a few things about a company I like to dig into when I’m trying to determine if it has the ability to maintain or improve its 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.

On the other hand, 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 two charts below show how New Toyo has fared against the three criteria from 2004 to 2014:

New Toyo's dividends and free cash flow New Toyo's balance sheet figures

Source: S&P Capital IQ

Let’s have a few quick words about New Toyo’s track record.

Over the timeframe we’re looking at, the company has managed to pay an annual dividend in each year and that’s a good thing.

But, the firm has had trouble growing its dividends (the pay-outs have in fact, shrank over the years). In addition, the important free cash flow metric hasn’t been growing and has also been very erratic. For further perspective on the free cash flow picture, it’s worth noting that New Toyo ended 2004 and 2014 with free cash flows of S$21.5 million and S$20 million respectively.

What’s more, the firm’s balance sheet had also been weak for the most part, as seen from how the level of borrowings has exceeded debt in the years from 2004 to 2011. The company has seen some improvement in its balance sheet in recent years, but it remains to be seen if that can be sustained.

A Fool’s take

Given what we’ve seen (the erratic free cash flow and the shrinking dividends), there’s a chance that New Toyo may not able to deliver steady dividends.

But that being said, it should be noted that this look at New Toyo’s historical financials is not a holistic overview of the entire picture. Investors would still have to dig into the qualitative aspects of the firm’s business and judge if better days are ahead.

A study of New Toyo’s financial history is important and informative, but more work definitely needs to be done beyond that before any investing decision can be made.

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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.