Investors who are on the hunt for shares with decent dividend yields now may have come across the blue chip stock, Sembcorp Marine Ltd (SGX: S51). The company, which is a blue chip by virtue of it being part of the 30 constituents of Singapore’s market barometer the Straits Times Index (SGX: ^STI), has a dividend yield of 4.7% at its current price of S$2.79 thanks to its annual ordinary dividend of S$0.13 per share in 2014. For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the Straits Times Index – has a yield of…
Investors who are on the hunt for shares with decent dividend yields now may have come across the blue chip stock, Sembcorp Marine Ltd (SGX: S51).
The company, which is a blue chip by virtue of it being part of the 30 constituents of Singapore’s market barometer the Straits Times Index (SGX: ^STI), has a dividend yield of 4.7% at its current price of S$2.79 thanks to its annual ordinary dividend of S$0.13 per share in 2014.
For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the Straits Times Index – has a yield of just 2.8% at the moment.
But, the fact that Sembcorp Marine has a market-beating yield does not automatically make it a good income share to invest in. What’s more important here is the company’s ability to maintain or raise its dividend in the future.
Building a strong yield
Generally speaking, there are a few things I like to find out about a company when I’m trying to determine if it has the potential to sustain or grow its payouts. Here they are:
- 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.
- 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.
- 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. In addition, it enables the firm to go on the offensive during a downturn and reinvest for growth even as its financially weaker competitors have to batten down the hatches.
Where Sembcorp Marine stands
The following charts show how Sembcorp Marine has fared against the three criteria over the past decade from 2004 to 2014:
Source: S&P Capital IQ
Two things to like about Sembcorp Marine are its track record in consistently paying a dividend in each year and the fact that it has raised its annual payout over time. But, that’s where the rosy picture stops.
As the first chart shows, Sembcorp Marine’s free cash flow has fallen dramatically since 2010 and the company has ended up with negative free cash flow in three of the last four years (in 2011, 2012, and 2014).
In the meantime, Sembcorp Marine’s balance sheet has also weakened considerably since 2010 with its cash levels decreasing and debt levels rising sharply. The tide has turned, so much so that a net-cash position of S$2.9 billion at end-2010 had become a net-debt position of S$660 million at end-2014.
Sembcorp Marine’s in the business of building oil rigs and other vessels that are related to the oil & gas industry. Given the lower price of oil that’s seen currently (the price of oil has fallen from more than US$100 per barrel in the middle of 2014 to around US$50 today), Sembcorp Marine’s business would naturally be under pressure and to that point, the firm mentioned in its earnings release for the first quarter of 2015 that it “faces a challenging year ahead.”
When we take Sembcorp Marine’s weak current business environment and combine that with a recent inability to generate free cash flow and a balance sheet that’s not exactly in the pink of health, it’d appear that the firm has a slim margin for error when it comes to protecting its dividends.
A Fool’s take
Sembcorp Marine’s history in paying a dividend is noteworthy, but given other aspects of its finances that we’ve seen, investors may want to be aware of the risk that the rig builder may not be able to maintain its dividends in the future.
All that being said, it’s worth noting that this look at the company’s historical financials is not a holistic overview of the entire situation. A deeper dive into the qualitative aspects of the rig builder’s business and an assessment of its ability to grow is also needed.
A study of Sembcorp Marine’s financial track record can be important and informative, but more work needs to be done beyond this before any investing decision can be reached.
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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 companies mentioned.