Is This Share With A 4.5% Yield A Good Dividend Stock?

Credit: Ethan Lofton

Investors out looking for a respectable dividend yield at the moment may come across Eu Yan Sang International Ltd (SGX: E02).

At its current price of S$0.485, the retailer of traditional Chinese medicines (TCM) has a nice yield of 4.5% thanks to its annual dividend of S$0.022 per share in its fiscal year ended 30 June 2014 (FY2014).

But, does this mean that Eu Yan Sang will make for a good dividend stock? Not so fast. What’s important here is the company’s ability to maintain or grow its payouts in the future and that’s not something which we can know from looking only at Eu Yan Sang’s yield.

Makings of a strong dividend

There are a few things in general that I like to dig into when I’m trying to assess the chances of a company being able to sustain or raise its dividends 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.

Eu Yan Sang’s dividend: Yay or Nay?

The following are two charts which show how Eu Yan Sang has fared against the three criteria over its last 10 fiscal years from FY2004 to FY2014:

Eu Yan Sang's total dividends (ordinary plus special) and free cash flow (FCF) per share

Eu Yan Sang's balance sheet figures

Source: S&P Capital IQ

The praiseworthy and immediately noticeable thing here is Eu Yan Sang’s good track record in paying a dividend. The firm has not missed a beat when it comes to dishing out the cash over the timeframe under study, and its payouts have even been steadily rising over time.

But when we move on, cracks start to appear. Eu Yan Sang has seen its free cash flow fall dramatically into deeper negative territory over the last three fiscal years from FY2012 to FY2014.

Meanwhile, the firm’s balance sheet had also weakened considerably over the same time frame, with its net-cash position of S$13.1 million at end-FY2011 becoming a net-debt position of S$82.4 million at end-FY2014.

Eu Yan Sang has been reinvesting heavily for growth in recent years, which partly explains the aforementioned drastic decline in free cash flow. If management’s investment acumen is right, these new investments can help power growth and lay the foundation for stronger dividends in the future.

But, given Eu Yan Sang’s negative free cash flow and already-weak balance sheet, the firm does not have much room for error to get things right in its investments for growth if it wants to protect its dividends.

A Fool’s Take

Eu Yan Sang has had a solid history with paying a dividend, so that may give investors some comfort in the firm’s ability to continue dishing out the cash.

But, there are still important risks to note with the company’s pay-out as I’ve discussed, like its lack of free cash flow and its growing leverage in recent years. For these reasons, there’s a chance that Eu Yan Sang may end up being a less-than-ideal dividend stock.

That being said, it’s worth pointing out that this look at the TCM retailer’s historical financials is not a holistic overview of the entire picture. Investors would still need to dig into the qualitative aspects of the firm’s business and consider if brighter days are ahead.

A study of Eu Yan Sang’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.

There're other interesting things to talk about when it comes to dividend investing. If you're interested to do so in person, you can 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.