The Motley Fool

A Better Conglomerate Dividend Stock: SembCorp Industries Limited vs. Singapore Technologies Engineering Ltd

A conglomerate can be simply understood as a company with many different types of businesses. There are many conglomerates in Singapore’s stock market and in fact, there are a number within the 30 blue chip shares that make up our local market barometer, the Straits Times Index (SGX: ^STI).

Among the group of blue chip conglomerates would be SembCorp Industries Limited (SGX: U96) and Singapore Technologies Engineering Ltd (SGX: S63).

The former has its fingers in utilities (think electricity generation and water treatment), offshore & marine engineering (the building of rigs and repair of vessels), and urban development. Meanwhile, the latter has its attention divided between a few distinct engineering business segments: Aerospace, Electronics, Land Systems, Marine, and Others.

You can probably tell from the above that SembCorp Industries and ST Engineering are two very different companies. But when it comes to their merits as dividend stocks, are there any big differences as well? Who would prevail?

For an answer to the questions above, we can compare some crucial things about the two conglomerates’ fundamentals: Dividend yields; dividend growth rates; balance sheet strength; and payout ratios.

Dividend yields

The dividend yield number for a stock tells us how much bang for our buck we’re getting from it. As a simple example of how this might work, a stock with a yield of 3% will be paying out an annual dividend of S$30 if we have S$1,000 invested in it. The higher a stock’s yield is, the fatter its payout would be for its investors.

ST Engineering just about edges ahead of SembCorp Industries here. At its current price of S$2.94, ST Engineering’s yield clocks in at 5.1% thanks to its annual dividend of S$0.15 per share in 2014. Meanwhile, SembCorp Industries is yielding ‘only’ 4.8% at its latest price of S$3.32 with its 2014 dividend of S$0.16 per share.

Dividend growth

The past is not a perfect indicator of the future. But, it can still give us a rough idea of what to expect. For this reason, a look back at a stock’s historical dividend growth is useful in helping us gain some perspective on what its dividends may look like in the years ahead.

Growth in total dividends (special + ordinary) for SembCorp Industries and ST Engineering

Source: S&P Capital IQ

This area is where SembCorp Industries comes out tops. From 2004 to 2014, the utilities provider and offshore & marine giant had seen its dividends grow by a total of 42%. ST Engineering’s dividend growth rate stood at only 21% in contrast.

Balance sheet strength

As investors, we have to understand that dividends do not come with guarantees. When a company has a weak balance sheet, its dividends run the risk of getting cut or removed completely – either due to a simple lack of cash or pressure from creditors – even at the slightest hiccups in its business.

A strong balance sheet, on the other hand, gives a company a better chance of protecting its dividends when there are inevitable downturns in the business environment from time to time.

Having a great balance sheet can even enable a firm to mount an offense during rough economic climates even as its financially-shakier competitors have to batten down the hatches. This helps plant the seeds for potentially higher dividends in the future.

As of 30 September 2015, SembCorp Industries and ST Engineering have net-debt (total debt minus total cash & equivalents) to equity ratios of 55% and 10%, respectively. Given ST Engineering’s lower ratio, you can tell that it has the stronger balance sheet of the pair.

Payout ratios

When it comes to gauging the room for error a company has to maintain or grow its dividends in the future, payout ratios can be very useful. There are two types of payout ratios that we’re interested in here: One measures a stock’s dividend as a percentage of its earnings (let’s call this the earnings payout ratio) while the other measures the dividend as a percentage of free cash flow (let’s call this the cash flow payout ratio).

Generally speaking, the lower the payout ratios are, the more buffer there is for a company to absorb untoward business developments.

Payout ratios for SembCorp Industries and ST Engineering in 2014

Source: S&P Capital IQ; author’s calculations

SembCorp Industries clearly outperforms ST Engineering in terms of the earnings payout ratio. But, the utilities and offshore & marine outfit had a negative cash flow payout ratio in 2014 – that isn’t healthy as it is an indication of the company’s inability to generate free cash flow.

On balance, ST Engineering would thus win the honours here. But even so, it must be noted that ST Engineering’s cash flow payout ratio in 2014 is 116.8% – in other words, the engineering conglomerate’s dividends exceeds its free cash flow and that’s not ideal.

A Fool’s take

In a roundup of the scores, ST Engineering is the ultimate winner here as it has bested SembCorp Industries in three of the four categories.

Notably, all that we’ve seen above shouldn’t be taken as the final word on the investing merits of the two stocks. A deeper look at other areas of their businesses – such as their future prospects – needs to be done before any investing decision can be reached.

For more insights on dividend investing and to keep up to date on the latest financial and stock market news, sign up now for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

Also, like us on Facebook to follow our latest hot articles. The Motley Fool's purpose is to help the world invest, better.

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.