Can The High-Yielding Keppel Corporation Limited Maintain Its Dividends?

Investors who have been out looking for high-yielding blue chips recently would likely have come across rig-builder and property developer Keppel Corporation Limited (SGX: BN4).

The company, which is considered a blue-chip by virtue of its status as one of the 30 constituents of the Straits Times Index (SGX: ^STI), has a lip-smacking yield of 6.9% at its current share price of S$6.92 thanks to its annual dividend of S$0.48 in 2014.

That’s a yield which is also way higher than the 3.3% that’s offered by the SPDR STI ETF (SGX: ES3), an exchange-traded fund tracking the fundamentals of the Straits Times Index.

But if you’d notice, the yield number is backwards-looking. In other words, it can’t tell us much about the most important thing here going forward: How Keppel Corp’s dividends might change.

Can the conglomerate maintain or grow its dividends? Or is the company’s high yield now a warning sign from the market that more trouble may be ahead?

Ingredients for a strong yield

The following’s not an exhaustive list for sure, but they contain some important financial numbers I like to look at when I’m trying to gauge a company’s ability to sustain or raise its payouts in the future:

  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.

Keppel Corp’s dividends: Yay or Nay

So how has Keppel Corp fared against the three criteria? Let’s look at the firm’s dividends and free cash flow first.

Chart 1 - Keppel Corp's ordinary dividends and free cash flow (FCF) per share

Source: S&P Capital IQ

As Chart 1 shows, Keppel Corp’s had an admirable track record of raising its ordinary dividends over the past decade from 2004 to 2014; in that period, there was only one year (2013) when it wasn’t able to distribute higher dividends to its shareholders.

But, Chart 1 also shows something troubling here: The lack of free cash flow. Keppel Corp’s free cash flow was climbing nicely up till 2008, after which it plummeted. As I had already mentioned, free cash flow’s the fuel for dividends and if Keppel Corp can’t pull that number back up, the conglomerate may have to struggle with its payouts.

Chart 2 - Keppel Corp's balance sheet figures

Source: S&P Capital IQ

Moving on to the balance sheet, there are also some worrying signs. Keppel Corp’s balance sheet has deteriorated significantly since end-2009 with the level of borrowings climbing at a much faster rate than cash as you can see in Chart 2.

Keppel Corp’s most recent quarter (the second-quarter of 2015), also sees its balance sheet continue to weaken with the net-debt position rising from S$1.71 billion at end-2014 to S$4.8 billion.

Companies with stable businesses that are not susceptible to wild swings are in a position to be able to assume high level of borrowings.

But that’s not really the case with Keppel Corp. The conglomerate’s two main business segments – the building of rigs for the oil & gas industry and the development of real estate – are both cyclical. The swing in sentiment can be really violent as well, as evidenced by how the price of oil has fallen to around US$40 per barrel today from a 2014-high of more than US$100 per barrel.

Given all that we’ve seen, Keppel Corp’s lack of free cash flow and debt-laden balance sheet may be obstacles in its quest to maintain or grow its dividends in the years ahead.

A Fool’s take

This look at Keppel Corp’s financial history has shown us some of the key risks that we should note with its future dividends. But that being said, there are other important aspects about the company that we’ve yet to look at (things like management’s capital allocation abilities and the economic future of the oil & gas and real estate markets that the company’s participating in).

A study of Keppel Corp’s financial track record is important and informative, but more work needs to be done beyond this before any investing decision can be reached.

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.