Can This Stock With An Attractive 6.5% Dividend Yield Sustain Its Dividends?

Payments solutions and telecommunications equipment provider Nera Telecommunications Ltd (SGX: N01) is a stock that might attract income investors.

At its current share price of S$0.54, it has a yield of 6.5% thanks to its annual dividend of S$0.035 per share in 2015. For some perspective, the firm’s yield of 6.5% is nearly twice the 3.5% yield that the SPDR STI ETF (SGX: ES3) has. The SPDR STI ETF is an exchange-traded fund which tracks the fundamentals of Singapore’s stock market barometer the Straits Times Index (SGX: STI).

But, it can be dangerous to invest in a company for dividends just because it has a high yield. The yield number tells us nothing about what’s important here: The company’s ability to sustain or raise its dividend in the future.

So, what should investors make of Nera Telecommunications? In here, let’s have a look at three charts which may give us useful insight on the company’s dividend.

The first chart we’re looking at (Chart 1) illustrates the company’s ordinary dividend over the past eight years from 2007 to 2015.

Chart 1 - Nera Telecommunications' ordinary dividend from 2007 to 2015
Source: Nera Telecommunications’ earnings reports

There are two things to like about Nera Telecommunications’ dividend track record. First, the company has been paying an annual dividend consistently in the years we’re looking at (the company did not pay a dividend in 2011, but had specifically ear-marked S$0.04 per share out of the total 2012 dividend of S$0.08 as an “in-lieu” payout for 2011). Second, while a history of growth would be preferable, the company’s annual dividends have still fallen within a tight range of S$0.04 to S$0.03 per share.

The next chart is Chart 2 and it shows Nera Telecommunications’ operating cash flow per share, free cash flow per share, and dividend per share over the same period as Chart 1.

Chart 2 - Nera Telecommunications' ordinary dividend, operating cash flow, and free cash flow per share from 2007 to 2015
Source: Nera Telecommunications’ earnings reports; S&P Global Market Intelligence

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

Generally speaking, the last choice is the most sustainable option for a company. This is where free cash flow comes into play. This financial metric measures the cash flow generated by a company’s business activities (known as operating cash flow) that’s left after the firm has spent the necessary monies needed to maintain its businesses at their current states. The more free cash flow a company can potentially generate in the future, the fatter its payouts can possibly be.

What Chart 2 portrays is worrying. From 2011 to 2012 2015, Nera Telecommunications’ operating cash flow has dwindled drastically and this has pressured free cash flow. It’s worth noting too that the company’s dividend in 2015 is nearly six times higher than the free cash flow generated.

We’re down to the last chart of the day and it shows the change in Nera Telecommunications’ net-cash position from 2007 to 2015 (where net-cash refers to total cash and short-term investments minus total borrowings and capital leases):

Chart 3 - Nera Telecommunications' net-cash position from 2007 to 2015
Source: S&P Global Market Intelligence

A company’s balance sheet is an important thing to look at when it comes to dividends. A strong balance sheet – one that has lots of cash and little debt – gives a company better odds of protecting its dividends even in challenging business environments. A weak balance sheet on the other hand – one that’s bloated with debt – lowers those odds.

Our last chart, Chart 3, shows that Nera Telecommunications still has a healthy balance sheet with a net-cash position of S$4.7 million. But, the bad thing is that the net-cash position has been falling in each year since 2011 and is now at the lowest level seen since 2007.

A Fool’s take

To sum it all up, there are things to like about Nera Telecommunications’ financial picture. The company has been paying a consistent dividend and it has a balance sheet that’s in good shape. But, there are also important risks that investors may want to consider, such as the firm’s inadequate dividend cover and dwindling free cash flow and net-cash position.

On balance, there appears to be a chance that Nera Telecommunications’ current level of dividend may not be sustainable.

That being said, it is worth pointing out that all that we’ve seen about Nera Telecommunications’ business here should not be taken as the final word on the investing merits (or lack thereof) of the company. A deeper study is needed 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.