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What Does Hour Glass Ltd’s Free Cash Flow Tell Investors About Its Dividend?

Hour Glass Ltd (SGX: AGS) is a retailer of luxury watches with over 40 boutiques scattered across six regions in Asia Pacific, namely, Singapore, Australia, Hong Kong, Thailand, Japan, and Malaysia.

The company carries over 50 high end watch brands in its boutiques, some of which are Audemars Piguet, Patek Philippe, Richard Mille, and IWC Schaffhausen.

One trait about Hour Glass that may appeal to income investors is its long track record of paying an annual dividend. It’s a record that has extended for more than 10 years.

But that is then and this is now. Just how sustainable is Hour Glass’s dividend? 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 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 to maintain its businesses at their current state. The 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 table showing how Hour Glass’s free cash flow and dividends paid have changed from its FY2012 (fiscal year ended 31 March 2012) to FY2016:

Hour Glass free cash flow table
Source: Hour Glass’s annual reports

We can see that Hour Glass has been paying more in dividends to shareholders than what it has generated in free cash flow over the timeframe we’re observing. From FY2012 to FY2016, the luxury watch retailer’s total free cash flow was S$63 million, short of the S$68 million in dividends paid.

But, the shortfall isn’t high. Plus, Hour Glass was also growing its business in that timeframe by expanding its store count.

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 for Hour Glass. As for the first and third, it turns out that:

1) Hour Glass’s profit has declined over the past few years despite revenue having grown, due to declining profit margins.

2) The company has a strong balance sheet.

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

In sum, despite the company’s declining profit margins, it has a decent track record with generating free cash flow and a strong balance sheet. This results in a high probability that Hour Glass can sustain its dividend.

But with everything being said, do also bear in mind that there are other important aspects about the stock to investigate, as I had mentioned earlier, when it comes to assessing the sustainability of its dividend.

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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.