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Check Out This Share If You Would Like To Enjoy Growing Dividends

Pan-Asian retailer Dairy Farm International Holdings Ltd (SGX: D01) is not a share that will send pulses racing amongst a crowd of investors who are looking for high dividend yields.

At its present price of US$8.76, Dairy Farm has a yield of just 2.6% thanks to its annual dividend of US$0.23 per share in 2014. In comparison, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a yield of 2.7% currently.

But despite its seemingly average yield now, Dairy Farm may just be a share that can please income investors of all stripes by virtue of its potential in being able to deliver growing dividends in the future.

The makings of an income-grower

There are a few things I like to dig into when I’m out looking for shares with the potential to steadily increase 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. The higher the company’s free cash flow can be over time, the larger the potential for growing dividends.

  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 the resources to protect its dividends during the inevitable tough times that rolls along every now and then.

We’ve an ace in the pack

As you can see in the two charts below, Dairy Farm has aced the three criteria over the decade from 2004 to 2014:

Dairy Farm's dividends and free cash flow

Dairy Farm's balance sheet figures

Sources: S&P Capital IQ

The company’s ordinary dividends have demonstrated a clear upward bias over the period under study; the firm has been able to consistently generate free cash flow that’s in excess of the dividends paid; free cash flow has steadily marched higher over time; and the balance sheet has improved markedly since 2007, ending 2014 with US$662 million in cash and just US$187 million in borrowings.

A Fool’s take

There are many things to like about Dairy Farm as a share with the potential for growing dividends. But, it’s worth noting that this look at the retail outfit’s historical financials is not a holistic overview of the entire picture.

Investors would still need to dig into the qualitative aspects of the company’s business and consider its future prospects. A study of Dairy Farm’s financial track record is important and informative, 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 owns shares in Dairy Farm International Holdings.