Is This Share With A 7.5% Dividend Yield A Good Dividend Stock?

Yield-hungry investors may easily be attracted to property development and construction outfit Chip Eng Seng Corporation Ltd (SGX: C29) currently like bees are to honey.

That’s because the company has a tantalizing dividend yield of 7.5% at its present share price of S$0.795 thanks to its total annual dividend of S$0.06 per share in 2014.

In contrast, 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 2.7% at the moment.

But, would Chip Eng Seng actually be a good dividend share that can maintain or even grow its dividends in the future? The company’s dividend yield – as attractive as it is – gives us nothing to answer the question with. Instead, the important clues are to be found in the firm’s business fundamentals.

Serving up some strong dividends

In general, there are a few things about a company’s fundamentals that I like to dig into when I’m trying to assess its ability to sustain 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.

Dividends are ultimately paid using the cash that a company has and that 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.

Chip Eng Seng’s dividend: Yay or nay?

The following are two charts showing how Chip Eng Seng has fared against the three criteria over the past decade ended 2014:

Chip Eng Seng's total dividends (ordinary plus special) and free cash flow (FCF) per share

Chip Eng Seng's balance sheet figures

Source: S&P Capital IQ

As the first chart shows, Chip Eng Seng has had a decent track record with paying a dividend; not only have there been annual payouts over the years we’re looking at, there’s also been a general upward climb in the firm’s dividend.

But, this is where the applause stops. From 2004 to 2014, Chip Eng Seng has had big issues with generating free cash flow in a consistent manner.

What might be even more worrying though, is the company’s alarming deterioration in the strength of its balance sheet over a relatively short period of time. I trust it’s obvious to see from the second chart that the firm’s borrowings have essentially sky-rocketed from 2009 onward, so much so that its net-debt position (total borrowings minus total cash) had grown from just S$47 million in 2009 to S$720 million at end-2014.

When we put the latter two traits together – the inability to generate free cash flow and a balance sheet that has weakened sharply – it’d appear that Chip Eng Seng has very little room for error when it comes to maintaining or growing its dividends in the future.

A Fool’s take

Given what we’ve seen, it seems that the only thing to like about Chip Eng Seng as a dividend stock would be its high yield. Investors would have to be aware of the risks that come with the firm’s dividends.

That being said, it’s worth noting that this look at the real estate outfit’s historical financials is not a holistic overview of the entire situation. Investors would still need to dig into the qualitative aspects of the company’s business and consider if brighter days are ahead.

A study of Chip Eng Seng’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.