What Does Keppel Corporation Limited’s Free Cash Flow Say About Its Dividend?

Keppel Corporation Limited (SGX: BN4) is one of the Singapore stock market’s largest conglomerates. It has four major business segments, namely, Offshore and Marine, Property, Infrastructure, and Investment.

The company has a track record of paying an annual dividend that goes back to at least 1989. But, the company’s dividend has been under pressure in the past two years; in 2014, 2015, and 2016, Keppel Corp’s dividend per share came in at S$0.48, S$0.34, and S$0.20 respectively.

The conglomerate’s falling dividends may raise an important question in investors’ minds: Is the current dividend sustainable?

Unfortunately, there is no easy answer. That said, there are some things about a company’s business we can look at for clues. Here are three of them, keeping in mind that they are not the only important aspects: (1) the company’s profit history, (2) a comparison of the company’s free cash flow and dividend, and (3) the company’s balance sheet strength.

In this article, I will address the second point. For the first and the third, you can check out here and here, respectively.

Free cash flow

For a company to be able to sustain its dividend payments, it must be able to generate cash to pay its bills and maintain its businesses at their current state. Left over cash can then be used to pay out dividends.

In the financial community, that left-over cash is known as free cash flow and it is found by subtracting a company’s capital expenditure from its cash flow from operations. It is not sustainable over the long-term for a company to pay out more in dividends as compared to the free cash flow it generates.

Here’s a chart showing how Keppel Corp’s free cash flow and dividends paid have changed from 2012 to 2016:

Keppel Corp free cash flow chart
Source: Keppel Corp’s financial statements

And for those who are interested in how the numbers are derived, please see the table below:

Keppel Corp free cash flow table
Source: Keppel Corp’s financial statements

From the above, we can see that Keppel Corp has been paying out more in dividends than it has been generating in free cash flow over the last five years. Moreover, from 2012 to 2016, the total deficit between the company’s free cash flow and dividends paid is nearly S$8.9 billion. This gap is funded mainly through the company’s cash hoard and debt.

Unless the company can improve its free cash flow going forward, its act of paying out more cash than it brings in is not sustainable in the long run.

A Foolish conclusion

Earlier in this article, I had shared three things about a company’s business investors could like at to give them clues on how sustainable the company’s dividend is. The second is something we have just studied. As for the first and third, it turns out that:

  1. Keppel Corp has a history of revenue, profit, and profit margin declines.
  2. The company has a sizeable cash hoard of $2.36 billion, and important debt-related ratios that are at acceptable levels.

(I had earlier shared the links for the analyses of Keppel Corp’s profit history and balance sheet strength. Here they are again for convenience: profit history and balance sheet strength.)

In sum, despite the negatives seen with Keppel Corp (lack of sustainable profits and a poor ability to generate free cash flow), the company’s cash hoard gives it the resources to pay out a dividend at the current rate for the next two to three years at least. (The cash hoard of S$2.36 billion is a few times larger than the dividend of S$545 million Keppel Corp paid in 2016.)

But, this rests on the important assumption that there is no further substantial deterioration in the company’s business environment over the next few years. Investors will have to pay attention for signs of any future improvement in free cash flow – as mentioned, Keppel Corp has been paying a dividend that’s not within its means, so the company has to grow its free cash flow in the long run.

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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 contributor Lawrence Nga doesn’t own shares in any companies mentioned.