Can This Stock With A Massive 10.5% Yield Be A Good Dividend Investment?

When it comes to high-yielding shares in the market, civil engineering and property development outfit Hock Lian Seng Holdings Limited (SGX: J2T) would be easily noticeable.

At its current share price of S$0.38, the company has a huge dividend yield of 10.5% thanks to its annual dividend of S$0.04 per share in 2014.

In contrast, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a yield of ‘just’ 3.3% at the moment.

But, a high yield alone won’t make Hock Lian Seng a good investment for dividends – what’s key here is the company’s ability to raise or sustain its payouts in the future.

Building a strong yield

When it comes to assessing 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.

Hock Lian Seng’s dividend: Yay or nay

Let’s start with the civil engineer’s dividends and free cash flow. You can see how the numbers for Hock Lian Seng has changed over the past five years from 2009 to 2014 in Chart 1 below:

Chart 1 - Hock Lian Seng's total dividends and free cash flow (FCF) per share

Source: S&P Capital IQ

Hock Lian Seng first started paying a dividend in 2009 (it got listed late that year; this is also why a longer timeframe isn’t used in Chart 1) and since then, it has managed to raise its payouts and consistently dish out the dough. Beyond that, the company has also been able to generate free cash flow more often than not. These are praise-worthy characteristics.

In Chart 2 below, we get to see how Hock Lian Seng’s balance sheet has changed over the same period as Chart 1:

Chart 2 - Hock Lian Seng's balance sheet figures

Source: S&P Capital IQ

For the timeframe we’re looking at, the civil engineer’s balance sheet has generally been rock-solid, with only one year (2012) in which the amount of borrowings had exceeded the level of cash; other years saw the company operate with minimal or zero debt.

A Fool’s take

Hock Lian Seng has done well against the three criteria and displayed some pleasing financials. This gives the firm plenty of room for error when it comes to sustaining or raising its dividends in the years ahead.

That being said, it’s worth noting that this look at Hock Lian Seng’s financial history is not a holistic overview of the entire picture. Investors would still need to study the qualitative aspects of the civil engineer’s business and consider if brighter days are ahead.

One pertinent issue to think about is the firm’s ability to win new civil engineering projects at prices that make economic sense. Currently, Hock Lian Seng has an orderbook for its civil engineering segment that’s worth S$430 million; as the number eventually becomes revenue for the firm, it’d pay for investors to keep an eye on how the orderbook changes.

A look at Hock Lian Seng’s historical financials can be important and informative, but more work needs to be done beyond that 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.