Why This Stock’s Mouth-Watering 9.1% Dividend Yield Is Full Of Risks

The aptly-named construction company Soilbuild Construction Group Ltd (SGX: S7P) is one stock with a mouth-watering dividend yield at the moment.

With its current share price of S$0.22 and 2015 dividend of S$0.02 per share, Soilbuild has a yield of 9.1%. This is more than double the 3.6% yield of the SPDR STI ETF (SGX: ES3), an exchange-traded fund that tracks the fundamentals of Singapore’s market benchmark, the Straits Times Index (SGX: ^STI).

But while Soilbuild may have a tasty yield, there’s a chance that income investors may get their mouths full of sand with the stock. I say this because of two charts.

The first chart plots Soilbuild’s dividend per share, operating cash flow per share, and free cash flow per share from 2010 to 2015 (the company was listed only in 2013 and so has a short track record to study).

Chart 1 - Soilbuild's total dividend, operating cash flow, and free cash flow per share from 2010 to 2015
Source: S&P Global Market Intelligence

Soilbuild started paying a dividend in 2013 and has continued paying an annual dividend since. Moreover, its dividends have also grown from S$0.015 per share in 2013 to S$0.020 per share in 2015. These are some likeable traits.

But, as Chart 1 shows, the company has failed to generate operating cash flow as well as free cash flow with any consistency over the period we’re looking at. These are important things to note.

A company ultimately pays its dividends with cash and it can obtain cash from a few ways. The firm can take on more debt, issue new shares, sell its assets, or simply generate cash from its daily business activities.

The last option is generally the most sustainable choice for a company and that’s where free cash flow enters the scene. Free cash flow measures the cash a company generates from its business (what’s known as operating cash flow) after it has spent the necessary capital needed to maintain its businesses at their current states. The higher a company’s free cash flow can be in the future, the more dividends it can possibly pay out.

Unfortunately, as I’ve mentioned earlier, Soilbuild has not shown an ability to reliably produce the raw fuel needed for dividends.

The next chart I’m interested in illustrates Soilbuild’s net-cash position (net-cash refers to total cash and short-term investments net of all borrowings and capital leases) for the same period as Chart 1.

Chart 2 - Soilbuild's net-cash position from 2010 to 2015
Source: S&P Global Market Intelligence

A few things to note from Chart 2:

  • First, Soilbuild’s balance sheet was not the strongest prior to its listing (the company had a negative net-cash position in 2010 and 2011); this suggests that the firm’s big improvement in its balance sheet in 2013 was largely the result of new funds flowing in from its initial public offering.
  • Second, the firm’s balance sheet has deteriorated markedly since 2013, with the net-cash position dropping from S$78.6 million to just S$7.8 million in 2015.

The balance sheet is an important aspect of a company’s business fundamentals to look at for investors. A company with a weak balance sheet – one that carries lots of debt – is at higher risk of having to remove or reduce its dividends when it runs into a poor business environment. It’s the opposite for a company with a sturdy balance sheet that is flush with cash and carries little debt.

A Fool’s take

To sum up what we’ve seen here, Soilbuild has struggled to generate free cash flow and has a balance sheet that has weakened pretty dramatically over the past few years. These are big risks to note for investors who are interested in the company as an income stock because of its high dividend yield.

But, the consolidated picture that Charts 1 and 2 depict should not be taken as the final word on the investing merits of Soilbuild. 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.