With A Nice Yield Of 4.3%, Is SembCorp Industries Limited A Good Blue Chip Dividend Stock?

At its closing level of 3,191 points today, Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI), is down by 10% from its 52-week high of 3,550 that was reached in mid-April this year.

The fall in the index has been the result of some dreadful declines in a number of blue chips (the 30 stocks which make up the Straits Times Index) over the past three months and SembCorp Industries Limited (SGX: U96) has been a big culprit with its shares down more than 15% in that period.

But this fall has also made the company a possible investing target for yield-hungry investors. At its current price of S$3.76, the utilities and offshore & marine conglomerate has a yield of 4.3% thanks to its annual dividend of S$0.16 per share in 2014.

Would SembCorp Industries make for a good dividend stock given its respectable yield now? An answer to this question would depend heavily on the firm’s ability to maintain or raise its dividends in the future.

Cooking up a strong yield

There are a few things in general that I like to dig into when I’m an assessing this:

  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.

SembCorp Industries’ dividend: Yay or Nay?

Here are two charts which show how SembCorp Industries has fared against the three criteria over the decade ended 2014:

SembCorp Industries' ordinary dividends and free cash flow (FCF) per share

SembCorp Industries' balance sheet figures

Source: S&P Capital IQ

The first chart makes it obvious that SembCorp Industries has done a great job over the years when it comes to dishing out dividends; over the period under study, the firm has not missed paying an annual dividend and those payouts have climbed steadily as well.

But, beyond this, there are some important areas of concern to note. The first chart also plots the evolution of SembCorp Industries’ free cash flow and we can see that the conglomerate has struggled to generate free cash flow consistently; even more worryingly, SembCorp Industries has seen its free cash flow fall steadily since 2008.

Moving on to the balance sheet, it’s worth noting how the strength of SembCorp Industries’ balance sheet had deteriorated significantly in 2014. For some perspective, SembCorp Industries had ended that year with a net-debt position of S$3.06 billion whereas it had clocked a net-cash position of S$360 million at end-2013.

SembCorp Industries has been busy spending capital these past few years (it’s partly why the firm’s free cash flow had declined) to plant the seeds for future growth. This is evident from the following stats:

  • Operational and in-development power capacity had more than doubled from 3,800 megawatts at end-2009 to 7,900 megawatts at end-2014.
  • Over the same period as above, the firm’s operational and in-development daily water-treatment capacity had also more than doubled from 4 million cubic metres to over 9 million cubic metres.

If all these new projects can be effectively monetized and are managed well, that’d be great news for SembCorp Industries’ shareholders. But, with its dwindling free cash flow and a balance sheet that’s bloated with debt, SembCorp Industries may not have too much room for error to get things right with its growth opportunities if it wants to sustain or raise its payouts in the future.

A Fool’s take

Despite SembCorp Industries’ status as a reputable blue chip stock and its attractive yield now, investors may still want to note the risks that are present with the firm’s dividends.

With that, here’s something else that’s important to know: A study of SembCorp Industries’ financial track record like what you’ve seen can be informative and crucial, but more work needs to be done beyond this (such as a deeper dive into the qualitative aspects of the conglomerate’s business) before any investing decision can be made.

Want to know more about dividend investing? If you do, then come meet David Kuo and the rest of the Fool Singapore team on August 15! 

Please join us at Invest FAIR Singapore on 15 August. (Suntec Centre, Booth B-16). Come chat with us at our booth, and see our MAS-licensed Director, David Kuo, give his official SGX investor presentation.

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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.