What’s Going To Happen To The Future Dividends Of Sembcorp Marine Ltd?

Sembcorp Marine Ltd (SGX: S51) had likely disappointed many of its investors back in February this year when it released its earnings for 2015. Not only had the company clocked a loss in the fourth-quarter of 2015 – the first since 2003 – its dividend for the year was also slashed by more than half from S$0.13 per share in 2014 to S$0.06.

Given this bad cut in Sembcorp Marine’s dividend, it may be natural for investors to ponder what the company’s future dividends may look like. Let’s turn our attention to two important charts which may give us crucial insight into the oil rig builder’s dividend.

The first chart in question, Chart 1, plots Sembcorp Marine’s operating cash flow per share, free cash flow per share, and dividends per share.

Chart 1 - Sembcorp Marine's total dividend, operating cash flow, and free cash flow per share from 2005 to 2015 (2)
Source: S&P Global Market Intelligence

Dividends are ultimately paid with cash and a company can obtain cash from a few different ways. It can take on more debt, issue new shares, sell its assets, and/or simply generate cash from its daily business activities. All these sources may be suitable depending on the circumstances, but generally speaking, the last option is the most sustainable choice for a company.

That’s where free cash flow comes into play. Free cash flow measures the actual cash flow generated from a company’s daily business activities (also known as the operating cash flow) that’s left after the firm has spent the necessary amounts needed to maintain its businesses at their current states. The more free cash flow that can gush out from a company’s businesses in the future, the higher its dividends can potentially be.

Coming back to Chart 1, there are worrying signs. As you can see, Sembcorp Marine has struggled to generate consistent operating cash flow over the past decade, let alone free cash flow. Moreover, as a result of a sharp increase in capital expenditures in recent years (from S$73 million in 2010 to S$932 million in 2015), Sembcorp Marine’s free cash flow numbers have sunk deep into negative territory with the situation appearing to be deteriorating.

The next chart I’m interested in is Chart 2, which shows Sembcorp Marine’s net-debt (total borrowings & capital leases minus cash & short-term investments) to equity ratio for the same period as Chart 1. In general, the higher the ratio is, the more debt a company has and thus, the weaker its balance sheet is.

Chart 2 - Sembcorp Marine's net-debt (total debt minus cash & short-term investments) to equity ratio from 2005 to 2015
Source: S&P Global Market Intelligence

The balance sheet of a company is an important thing to look at when it comes to dividends. A strong balance sheet – one that isn’t heavily saddled with debt – gives a company higher odds of protecting its dividends when it’s faced with a challenging business environment. On the other hand, a weak balance sheet – one that’s bloated with debt – reduces those odds.

There have been recent examples of companies having to slash their dividends because of financial strains their balance sheets are under. Australian mining outfit BHP Billiton Limited is one.

In February this year, the company had announced its latest earnings and reduced its dividend by around 75%. This comes after it commented last November that it’s making its balance sheet a priority over raising its dividend. Back then, the firm’s latest financials (for the six months ended 30 June 2015) showed that it had a shaky balance sheet with US$31.2 billion in total debt and just US$6.75 billion in cash and equivalents.

Returning to Chart 2, it is painting a grim picture. Sembcorp Marine’s net-debt had spiked from S$660 million in 2014 to S$2.75 billion in 2015, leading to the firm’s net-debt to equity ratio ballooning from 21% to 103%. The ratio for Sembcorp Marine is now the highest it’s been over the decade we’re looking at.

A Fool’s take

Given Sembcorp Marine’s inability to generate free cash flow and its weakening balance sheet, as we’ve seen in Charts 1 and 2, it’d appear that the firm has very little room for error when it comes to protecting its future dividends.

That’s especially so when we consider that the price of oil has fallen by over 60% from its peak of over US$100 per barrel in mid-2014 to around US$40 today; Sembcorp Marine’s in the business of building oil rigs, and so its business has links to the price of the commodity.

All that being said, it’s worth noting that this look at Sembcorp Marine’s historical financials, while important and insightful, is not a holistic overview of the entire situation. Deeper research is needed before any investing decision can be reached.

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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.