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Is Sembcorp Industries Limited’s Dividend Safe?

Utilities and marine engineering conglomerate Sembcorp Industries Limited (SGX: U96) released its earnings for the fourth quarter of 2016 in late February and announced a final dividend of S$0.04 per share, bringing its dividend for the whole of 2016 to S$0.08.

That dividend represents a 27% decline from 2015’s total dividend of S$0.11 per share. With the reduction in dividend comes a big question: How safe is Sembcorp Industries’ dividend?

Let’s look at three charts that I think can give investors important insight into the safety of the conglomerate’s dividend.

The first chart, Chart 1, plots Sembcorp Industries’ ordinary dividend over the past decade from 2006 to 2016.

What we can see is that the company has a track record of paying an annual dividend for the timeframe under study, even throughout the Great Financial Crisis of 2008-09, and that’s a positive trait. The negative thing about Chart 1 is that it clearly shows how the company’s dividend has struggled to grow over the past decade.

Chart 1 - Sembcorp Industries' ordinary dividend from 2006 to 2016
Source: S&P Global Market Intelligence

Moving on to our next chart, Chart 2, it shows Sembcorp Industries’ operating cash flow per share, free cash flow per share, and dividends per share, also for the years stretching from 2006 to 2016.

A company’s dividends are ultimately paid with cash. That cash can be obtained by the company from a number of ways, such as, (1) borrowing from banks and investors, (2) issuing new shares to investors, (3) selling assets, and (4) collecting the cash generated from its businesses.

The first three options are generally unsustainable over the long-run, leaving us with the fourth option. That’s why it’s important to watch a company’s free cash flows. It is the actual cash flow from a company’s business that’s left after the firm has spent the capital necessary to maintain its businesses at their current states. The more free cash flows a company can produce in the future, the higher its potential for fatter dividends in the years ahead.

What Chart 2 shows is disappointing. Sembcorp Industries has failed to produce any consistent growth in operating cash flow in the years under observation, which has led to erratic free cash flow production.

There was a two-year trend, in 2014 and 2015, which saw the company’s free cash flow fall steeply while in negative territory; this has reversed sharply in 2016, but it remains to be seen if the improvement can hold in future years.

Chart 2 - Sembcorp Industries' total dividend, operating cash flow, and free cash flow per share from 2006 to 2016
Source: S&P Global Market Intelligence

The last chart I have is Chart 3, which illustrates Sembcorp Industries’ net-debt (total debt and capital leases minus cash and short-term investments) to equity ratio from 2006 to 2016.

Dividends are not covered by any guarantees. If a company’s balance sheet is weak, any deterioration in its business environment can result in a reduction or elimination of its dividend to meet creditors’ demands or to safeguard its financial health.

With Chart 3, we can see that Sembcorp Industries’ net-debt to equity ratio at end-2016 is 88%. That’s not low, and is actually at a 10-year high.

Chart 3 - Sembcorp Industries' net-debt to equity ratio from 2006 to 2016
Source: S&P Global Market Intelligence

To sum up what we have seen with the three charts, from 2006 to 2016, Sembcorp Industries has (1) not managed to pay a steady dividend, (2) failed to produce free cash flow with any consistency, and (3) seen its balance sheet weaken considerably in recent years.

Based on the three charts alone, Sembcorp Industries’ dividend does not appear to be particularly safe given the risks involved. But, it’s also important to carefully consider the prospects for the conglomerate’s business – something which I’ve not done – before any firm investment decision can be reached.

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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.