Will This Stock With A Dividend Yield Of 9.4% Make For A Good Income Share?

Logistics outfit Cogent Holdings Ltd (SGX: KJ9) will be near the top of the list for anyone who’s screening for shares with high dividend yields now.

At its current price of S$0.40, Cogent, which earns its keep mainly from providing transportation management services and warehousing & property management services, has a great yield of 9.4% thanks to its annual dividend of 3.76 Singapore cents in 2014.

For some perspective, 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 2.8% at the moment.

But, investors shouldn’t rush to buy just because Cogent has an attractive yield now. Instead, we should be looking at the company’s business fundamentals to determine the chances of it being able to maintain or even grow its payouts in the future.

Dishing out the cash

Generally speaking, there are a few things about a company I like to dig into when I’m trying to make that assessment:

  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.

Cogent’s dividend: Yay or nay?

The two charts below show how Cogent has fared against the three criteria since 2010. I’ve not looked at a longer-term track record simply because the company was listed only in February of that year.

Cogent's total dividends (ordinary + special) and free cash flow (FCF) per share

Cogent's balance sheet figures

Source: S&P Capital IQ

There seem to be many areas of concern with the company’s dividends.

First, Cogent has missed paying a dividend (in 2011) even with its short history as a publicly-listed company.

Second, the logistics outfit may be adept at transporting goods from point A to point B or managing warehouses, but it hasn’t been as good in producing free cash flow from its business. As the first chart shows (note the red line), Cogent’s free cash flow has been erratic and growth in the financial metric has been inconsistent.

Lastly, the company’s balance sheet has deteriorated significantly over the past two years, with debt ballooning in 2013 and 2014. This has caused Cogent to end 2014 with S$113.5 million in borrowings and just S$53.5 million in cash.

When we put the trio together, it’d appear that Cogent does not have a wide margin of safety when it comes to sustaining or raising its payouts in the years ahead.

A Fool’s take

With the view we have of Cogent, it seems that the only thing that’s attractive about the company as an income share is its high dividend yield. But that said, it’s worth noting that this look at the logistics outfit’s historical financials is unable to give us the complete picture.

Investors would still need to dig into the qualitative aspects of Cogent’s business and consider the odds of the company being able to grow in the future. A study of Cogent’s financial track record, like what we have here, can be important and informative, but more work needs to be done beyond this before any investing decision can be made.

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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.