Is This Share With A Delicious Yield Of 10.5% A Good Dividend Stock?

The recent sharp stock market decline have led to many stocks carrying attractive-looking yields. Dyna-Mac Holdings Ltd (SGX: NO4) would be one of those stocks.

Over the past three months, shares of the offshore engineering outfit have declined by half. At its current price of S$0.143, Dyna-Mac, which earns its keep mainly from the construction of offshore FPSO (floating production storage offloading) and FSO (floating storage offloading) topside modules, fetches a handsome yield of 10.5% thanks to its annual dividend of S$0.015 in 2014.

For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a dividend yield of just 3.2% currently.

But, having a market-beating yield alone does not make Dyna-Mac a good dividend stock. What’s more important here is the company’s ability to sustain or even grow its dividends in the future.

Building blocks for a strong dividend

To asses that, there are a few things in general about a company that I like to dig into:

  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.

Dyna-Mac’s dividend: Yay or Nay?

Here are two charts which show how Dyna-Mac has fared against the three criteria over its past four completed fiscal years (a longer history isn’t shown because the company got listed only in March 2011):

Dyna-Mac's ordinary dividends and free cash flow (FCF) per share (2)

Dyna-Mac's balance sheet figures (2)

Source: S&P Capital IQ

For the timeframe we’re looking at in the charts above, Dyna-Mac has done a good job in dishing out a dividend in each year consistently. But, it’s all downhill from here.

As the first chart also shows, Dyna-Mac’s dividend in 2014 had dipped slightly from a year ago. Meanwhile, in the four fiscal years under study, the oil & gas engineering firm has failed to produce any free cash flow; the important financial metric has in fact, slipped even deeper into negative territory.

On the balance sheet front, Dyna-Mac had also seen its financial strength deteriorate significantly over the period we’re observing in the charts above. To that point, the company’s net-cash position of S$64 million at the end of 2012 had become a net-debt position at end-2014.

In the first-half of 2015, Dyna-Mac’s business had suffered greatly (its revenue sank by 57% year-on-year while a profit of S$14.7 million a year ago had become a loss of S$6.9 million) partly as a result of the collapse in the price of oil which had taken place since the second-half of 2014. Management still sees challenging times ahead for the whole oil & gas market in the near-term future at least.

Meanwhile, although Dyna-Mac’s cash flow picture had been much healthier in the first-half of 2015 as compared to a year ago, its balance sheet had worsened yet further with more debt being slathered on the books.

When we consider everything we’ve seen so far, it’d appear that Dyna-Mac has very little room for error when it comes to protecting its dividends.

A Fool’s take

Dyna-Mac has an okay-but-short history thus far with paying a dividend. But, there are a whole host of important risks to note with the company’s pay-out (such as its lack of free cash flow, its growing leverage, its weak balance sheet, and a very soft business environment for oil & gas-related companies).

For these reasons, there’s a chance that Dyna-Mac may end up being a less-than-ideal dividend stock.

That being said, investors should note that this look at the offshore engineering company’s historical financials is not a holistic overview of the entire picture. Investors would still need to dig deeper into the qualitative aspects of the firm’s business and consider if brighter days are ahead.

A study of Dyna-Mac’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.