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2 Charts That Should Worry Investors About The Dividends Of Sembcorp Industries Limited

When it comes to investing for dividends, there are a number of important things about a company that investors should study.

Three such things are: A company’s track record with paying a dividend; the company’s ability to generate free cash flow; and the strength of the company’s balance sheet.

In the case of Sembcorp Industries Limited (SGX: U96), investors may have some things to worry about if we are to look at the company’s dividends through the three lenses above.

I could describe the company’s dividend-history, free cash flows, and balance sheet with words, but I thought charts would be way more useful. So, let’s have a look at some charts.

The first, Chart 1, plots Sembcorp Industries’ total per-share dividend (this includes ordinary and special dividends) for the 10-year period from 2005 to 2015:

Chart 1 - Sembcorp Industries' total dividend per share from 2005 to 2015
Source: S&P Global Market Intelligence

The year 2006 had a big special dividend of S$0.31 per share which skews the chart, but other than that, the company has kept its dividend within a relatively tight band of SS$0.11 per share to S$0.182 per share. That’s a likeable trait. Another positive aspect found in Chart 1 is the fact that Sembcorp Industries has been paying a dividend in each year over the past decade.

Now, let’s move on to the second chart, Chart 2, which illustrates Sembcorp Industries’ operating cash flow per share, free cash flow per share, and dividend per share for the same time frame as Chart 1.

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

You can see from Chart 2 that Sembcorp Industries’ operating cash flow and free cash flow have both declined dramatically into negative territory in 2014 and 2015. The company paid a dividend of S$0.11 per share in 2015, but it had negative per-share operating cash flow and free cash flow numbers of S$0.39 and S$1.19.

Dividends are ultimately paid with cash and a company can obtain cash in a number of ways, such as issuing debt or new shares, selling assets, or simply generating cash from its business. There are always exceptions, but the last option is generally the most sustainable choice.

This brings me to free cash flow. It is the actual cash generated from a company’s business that is left after the firm has spent the necessary capital needed to maintain its businesses at their current states (in finance-speak, free cash flow equals to operating cash flow minus capital expenditure).

The higher a company’s free cash flow can possibly be in the future, the fatter its dividends could be. This is why Chart 2 shows something worrying – Sembcorp Industries’ operating cash flow and free cash flow have both fallen hard in recent years. If the trend holds, the company may have difficulty in sustaining its dividend.

Chart 3 is the last chart we’re looking at. It shows Sembcorp Industries’ net-debt to equity ratio from 2005 to 2015:

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

Dividends don’t come with guarantees. If a company has a weak balance sheet (one that carries lots of debt), it may be forced to slash or eliminate its dividends in order to protect its balance sheet should there be any hiccups in its business.

Chart 3 is thus a worrying sign: Sembcorp Industries’ balance sheet has become weaker over the years, ending 2015 with a net-debt to equity ratio of nearly 80%.

A Fool’s take

While Sembcorp Industries may have a decent track record when it comes to paying a dividend, its balance sheet has grown a lot weaker in recent years. Moreover, it has also struggled to generate cash flow from its business.

What Charts 2 and 3 show should not be seen as definite signs that Sembcorp Industries’ future dividends are in trouble. But, they are important risks to the company’s dividend that investors may want to keep in mind.

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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.