Can StarHub Ltd Sustain Its Current Dividend?

StarHub Ltd (SGX: CC3), Singapore’s second largest telecommunications outfit, had just released its full-year and fourth-quarter earnings for 2015 on Tuesday. The telco had maintained its dividend for the year at S$0.20 per share and had also guided for S$0.20 per share in dividend for its current fiscal year (2016).

At its share price of S$3.53 at the moment, StarHub thus has a forward dividend yield of 5.7%. That looks juicy. And when it is coupled with the telco’s sizeable market capitalisation that’s north of S$6 billion, the company is likely to be a popular – or at least well-known – dividend stock for investors here in Singapore.

It’s for these reasons that I thought it may be a good idea to take a look at the telco’s ability to sustain or grow its S$0.20 per share dividend in the future.

History has shown that StarHub has been adept at keeping its promises – at least when it comes to its dividends. You can see StarHub’s dividend-guidance and actual payouts in each year going back to 2010 in the table below:

StarHub forecast and actual dividend table
Source: StarHub’s earnings releases (click table for larger image)

But, a look beneath the hood reveals that there are some weaknesses with certain areas of StarHub’s business fundamentals at the moment. Check out the following chart which illustrates StarHub’s per-share dividends, cash flow from operations, and free cash flow from 2010 to 2015:

StarHub's dividend, cash flow from operations, and free cash flow per share from 2010 to 2015
Source: S&P Global Market Intelligence; author’s calculations (click chart for larger image)

Dividends are ultimately paid for by a company using cash and that cash can from a few sources. The firm can (1) take on more debt, (2) issue new shares, (3) sell assets, and (4) generate cash from its daily business operations.

Free cash flow is a measure of the fourth option, which is generally speaking, the most sustainable option for a company. It is the actual cash flow from a company’s business operations that’s left after the firm has spent the capital needed to maintain its businesses at their current state. The higher a company’s free cash flow can be over time, the larger the potential for fatter dividends in the future.

In StarHub’s case, what’s a little worrying is its declining cash flow from operations and free cash flow. Moreover, in 2015, the firm’s dividend had come in nearly 70% higher than the free cash flow generated – in other words, the telco’s dividend is not adequately covered by its free cash flow at the moment.

Another area with weakness would be StarHub’s balance sheet. There are no guarantees when it comes to dividends. When a company’s balance sheet becomes weak as a result of heavy borrowings, its dividend is at risk of being eliminated or reduced – because of pressure from creditors or a desperate need for cash – even at the slightest temporary downturn in its business environment.

What the chart below shows is that StarHub’s net debt position (total debt minus cash) has climbed in 2015 and is now near the highest it’s been since 2010.

StarHub's net debt (total debt minus cash) from 2010 to 2015
Source: S&P Global Market Intelligence; author’s calculations (click chart for larger image)

To sum up what we’ve seen, StarHub’s free cash flow has been declining and can’t cover its dividend payments at the moment. Moreover, its balance sheet is in a net debt position and has become weaker over the past year.

These are not the healthiest of signs. But, do note that they are not meant to be taken as a guarantee that StarHub’s dividends will dwindle in the years ahead.

That said, given the potential for competitive pressures in Singapore’s telco market to heat up considerably in the near future with the potential entry of a fourth telco player – there are only three in the market currently with Singapore Telecommunications Limited (SGX: Z74) and M1 Ltd (SGX: B2F) being the other two – StarHub’s free cash flow and balance sheet can be important areas of risk for investors to watch when it comes to the company’s dividend.

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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.