This Stock Has A Tasty Yield Of 6.8%, But Are Its Dividends Safe?

Investors who are out looking for stocks with high dividend yields may have come across ready-mixed concrete and cement supplier Pan-United Corporation Ltd (SGX: P52). At its current share price of S$0.625, the company has a tasty yield of 6.8% thanks to its annual dividend of S$0.0425 per share for 2015.

In comparison, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a yield of just 3.5% at the moment.

But, just because Pan-United has an attractive dividend yield now does not make it a good income stock. In fact, basing investing decisions on just a stock’s yield alone is dangerous. That’s because a stock’s yield contains zero information about what’s important: The fate of the company’s dividend in the future.

With these in mind, what should investors make of Pan-United’s payouts? Let’s take a look at three charts which may give us some good insight on the subject.

The first chart we’re starting with is Chart 1, which plots Pan-United’s ordinary dividends over the 10 year period from 2005 to 2015.

Chart 1 - Pan-United's ordinary dividend from 2005 to 2015
Source: S&P Global Market Intelligence

There are both good and bad takeaways from Chart 1. The good thing is that Pan-United has managed to consistently pay an annual dividend over the decade we’re looking at. That could be a sign pointing to the stability of the company’s business.

But, the bad thing I see in Chart 1 is that there’s no clear trend of growth in Pan-United’s dividend. In 2008, the firm’s dividend had fallen by nearly 40% from S$0.0456 per share in 2007 to just S$0.028. The concrete supplier’s dividend has also been stuck at the level of S$0.0425 since 2013.

Dividends are ultimately paid with cash and a company can obtain cash from a few ways such as taking on debt, issuing new shares, selling assets, or generating cash from its daily business activities.

In general, the last option is the most sustainable one for a company. That’s where a company’s free cash flow comes into play. It measures the actual cash flow generated by a company’s business activities (known as operating cash flow) that’s left after the firm has spent the necessary capital needed to maintain its businesses at their current states. The higher a company’s free cash flow can be over time, the fatter its future dividends can potentially be.

Chart 2 below shows us Pan-United’s operating cash flow per share, free cash flow per share, and dividend per share for the same 10-year period as Chart 1.

Chart 2 - Pan-United's ordinary dividend, operating cash flow, and free cash flow per share from 2005 to 2015
Source: S&P Global Market Intelligence

What jumps out at me is the significant deterioration in the company’s free cash flow in 2014 and 2015 – the important financial metric was negative for both years.

The last chart we’re looking at, Chart 3, concerns Pan-United’s balance sheet. Dividends don’t come with guarantees. A strong balance sheet – one that is flush with cash and with little debt – gives a company higher odds of protecting its dividends even during times when its business environment becomes challenging. On the other hand, a weak balance sheet – one that is saddled with high levels of debt – reduces those odds.

Chart 3 illustrates the change in Pan-United’s net-debt to equity ratio (where net-debt refers to total borrowings and capital leases minus cash and short-term investments) from 2005 to 2015. Generally speaking, the higher the ratio, the more debt a company has, and thus the weaker its balance sheet.

Chart 3 - Pan-United's net-debt to equity ratio from 2005 to 2015
Source: S&P Global Market Intelligence

The picture looks gloomy. Pan-United’s net-debt to equity ratio has climbed markedly in the past three years. At the end of 2015, the ratio stood at an elevated level of 79%, the highest it’s been since 2005.

A Fool’s take

Summing it all up, while Pan-United has managed to dish out an annual dividend in each year without fail since 2005, both its ability to generate free cash flow and the health of its balance sheet have deteriorated significantly over the past few years. These are important risks with the company’s dividend that investors may want to think about.

But, it’s worth noting that all we’ve seen about Pan-United’s business here should not be taken as the final word on the investing merits of the company. A deeper study is required before any investing conclusion 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.