Will Singapore Telecommunications Limited Make For A Good Dividend Stock?

The aptly-named telco Singapore Telecommunications Limited (SGX: Z74) is a real heavy-weight in Singapore.

Not only is Singtel the largest company amongst the Straits Times Index’s (SGX: ^STI) 30 constituents, it’s also the largest player in Singapore’s telco scene, lording over second-placed Starhub Ltd (SGX: CC3) and third-placed M1 Ltd (SGX: B2F).

Besides being able to get their hands on a company with market dominance, new investors in Singtel can also get a tasty dividend yield; at its current price of S$4.29, Singtel has a yield of 4.1% thanks to its annual dividend of S$0.175 per share in the fiscal year ended 31 March 2015 (FY2015).

For some perspective, the SPDR STI ETF (SGX: ES3), an exchange-traded fund tracking the fundamentals of the Straits Times Index, has a trailing yield of only 2.8% at the moment.

But while Singtel is a leader in its field and has a nice yield, it’s still important to think about one key question: Can it sustain or grow its dividends in the future?

Let’s build a strong dividend

There are a few things in general that I like to dig into when I’m trying to asses a company’s ability to maintain or raise its payouts in the years ahead:

  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 come 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.

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; this plants the seeds for potentially higher dividends in the future.

Singtel’s dividend: Yay or Nay?

Here are two charts which show how Singtel stacks up against the three criteria for the decade ended FY2015:

Singtel's ordinary dividends and free cash flow (FCF) per share

Singtel's balance sheet figures

Source: S&P Capital IQ

I’d lead off with the praise-worthy aspects first.

In the first chart, I trust it’s fairly obvious to see that Singtel has not only been consistently paying an annual dividend in each fiscal year, the firm’s ordinary dividends have also been tracing a nice upward path.

Furthermore, Singtel also has a great track record of consistent free cash flow production and the financial metric has been coming in higher than the dividends paid.

But – and here’s where the areas of concern pop up – it’s worth noting that Singtel’s free cash flow has been growing at a slower pace than its dividends; you can get a sense of this from how the gap between Singtel’s dividends per share and free cash flow per share has narrowed over the past decade.

If Singtel can’t accelerate its free cash flow growth, its dividends may be raised at a slower pace in the future or there may even be no growth in the payouts at all.

The company’s balance sheet is also not the healthiest, seeing that the amount of borrowings has been consistently higher than the amount of cash. What may also be worrying here is that the amount of cash that Singtel has on hand has been dwindling (note the downward sloping black line in the second chart) over the timeframe under study even as the level of borrowings has been relatively fixed.

The areas of concern (the slow growth in free cash flow; the catching up of the dividends to the free cash flow; and the weakening balance sheet) when put together, paint a picture of a company that may not have much wiggle room to spare when it comes to raising, or even maintaining, its dividends in the future.

A Fool’s take

Given what we’ve seen with Singtel, despite its status as a solid blue-chip stock, investors may still want to note the risks that may come with the firm’s dividend – namely that future growth in the payouts may be stunted and that the firm’s widening net-debt (total debt minus total cash) position may make it tough for Singtel to even maintain its payouts.

That being said, this look at the telco’s historical financials is not a holistic overview of the entire picture. A deeper dive into the qualitative aspects of the company’s business as well as an assessment of its ability to grow is also needed.

A study of Singtel’s financial track record can be important and informative, but more work needs to be done beyond this 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 companies mentioned.