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Can You Count On This 6.3% Yield For Dependable Dividends?

Investors who are sifting through the market for shares with attractive dividend yields right now may have come across Hafary Holdings Ltd (SGX: 5VS).

At its current price of S$0.205, the flooring materials supplier has a tasty yield of 6.3% thanks to its annual dividend of S$0.013 per share in FY2014 (financial year ended 30 June 2014).

In contrast, the SDPR 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 2.66% at the moment.

But, having a high yield alone does not make Hafary a good income share. What’s more important here is the company’s ability to maintain or (even better!) grow its dividends over time. In other words, we’re asking this key question: Can we count on Hafary for dependable dividends?

The makings of a strong yield

There are a few things I like to look at when I’m trying to determine if a company has the ability to pay consistent dividends:

  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.

The verdict of history

Here’re two charts which show how Hafary has fared against the three criteria since FY2010 (the company was listed only in December 2009):

Hafary's dividends and free cash flow

Hafary's balance sheet figures

Sources: S&P Capital IQ

Let’s have a few words about the charts.

Hafary started paying a dividend in FY2010 (it’s a tiny amount – only S$0.002 per share – and so it doesn’t really register in the chart) and has managed to consistently deliver an annual payout since. That’s a plus.

But, as the first chart shows, the company’s dividends have been erratic and it has not been able to generate any free cash flow at all for the timeframe under study. These are certainly areas of concern.

Another thing to watch out for would be Hafary’s weak balance sheet. Besides having the amount of debt consistently exceed the amount of cash, Hafary’s borrowings have also rocketed. High debt-levels are not always a sign of trouble, but it does expose a company to more financial risks and that’s why it’s something investors may want to keep an eye on.

A Fool’s take

Given what we’ve seen – the erratic dividend, negative free cash flow, and deteriorating balance sheet – it seems fair to say that Hafary can’t be counted on for dependable dividends.

That being said, it’s important to note that this look at Hafary’s historical financials is not a holistic overview of the entire picture. Investors should still investigate the qualitative aspects of the company’s business and consider if better days are ahead.

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

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.