Sembcorp Industries Limited Illustrates 2 Danger Signs To Look Out For In Dividend Stocks

Last week, the utilities and marine engineering conglomerate Sembcorp Industries Limited (SGX: U96) released its earnings for the fourth quarter of 2016 and proposed a final dividend of S$0.04 per share, which is down 20% from the final dividend in 2015.

All told, Sembcorp Industries’ total dividend for 2016 is S$0.08 per share, some 27% lower than its total dividend of S$0.11 per share seen in the previous year.

Thing is, there were early signs that the company’s dividend for 2016 was at risk of being lowered from the level seen in 2015. In an article I published almost a year ago titled 3 Charts Investors Should See About the Dividends of Sembcorp Industries Limited, I shared the following chart on the conglomerate’s operating cash flow per share, free cash flow per share, and dividends per share from 2005 to 2015:

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

In my earlier article, I described the problems that were apparent in the chart:

“So, there are some troubling signs with Chart 2.

First, Sembcorp Industries’ operating cash flow has fallen deep into negative territory in 2015.

Second, it hasn’t been able to generate free cash flow on a consistent basis over the past five years; in fact, the conglomerate has seen negative free cash flow in four out of the five years from 2011 to 2015.

Third, Sembcorp Industries’ ability to generate free cash flow appears to have weakened significantly in recent years judging from the deep negative figures and the downward-slope of the metric seen in Chart 2.”

The next chart you see below also comes from my earlier article and it shows how Sembcorp Industries’ net-debt to equity ratio had changed from 2005 to 2015:

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

What the chart showed was that the conglomerate’s balance sheet at end-2015 was at its weakest, based on the net-debt to equity ratio, over the decade under study. In 3 Charts Investors Should See About the Dividends of Sembcorp Industries Limited, I described the risks to a company’s dividend that a weak balance sheet can bring:

“Dividends don’t come with guarantees. If a company’s balance sheet is weak as a result of high debt, it can easily choose to reduce or completely eliminate its dividends in order to protect its balance sheet when faced with a poor business environment.”

Toward the end of my earlier article, I wrote the following:

“I’m not trying to say here that Sembcorp Industries is necessarily a poor dividend stock. But, the current situation with the conglomerate’s cash flow and balance sheet are important risks investors may want to consider when looking at the company.”

And as we’ve observed from Sembcorp Industries’ dividend for the whole of 2016, an inability to produce free cash flow and a weak balance sheet can lead to painful cuts in a company’s dividend.

The appearance of the two danger signs – a lack of free cash flow and a debt-ridden balance sheet – does not always mean that a company’s dividend is facing a sharp and imminent reduction. But when the signs show up, there better be good reasons why they are there.

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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 company mentioned.