What Does M1 Ltd’s Free Cash Flow Tell Investors About Its Dividend?

M1 Ltd  (SGX: B2F)  is the smallest operational telco in Singapore.

The company has a long record of paying an annual dividend that stretches back at least a decade. But this raises a crucial question: Is M1’s dividend sustainable? The question gains even more importance when we consider the fact that the telco’s dividend in 2016 had declined by 16% compared to 2015.

Unfortunately, there is no easy answer to the question. But, 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 in their current state. The left over cash can then be used to pay 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 M1’s free cash flow and dividends paid have changed from 2012 to 2016:

Source: M1’s financial statements

We can see that M1 has been paying more in dividends to shareholders than it has generated in free cash flow over the timeframe we’re studying. From 2012 to 2016, M1 paid a total of S$654 million in dividends, while it generated only S$558 million in free cash flow. The shortfall of nearly S$100 million was funded mainly by borrowings.

A Foolish conclusion

Earlier in this article, I had shared three things about a company’s business that investors could look at for clues about a sustainable dividend. The second is something we have just studied for M1. As for the first and third, it turns out that:

1) M1’s profit margin and net profit have remained stable from 2012 to 2016. Although, there was a sharp dip in profit in 2016 when compared to 2015.

2) The company has a weak balance sheet given its low cash balance sheet and high debt to shareholders’ equity ratio.

(I had earlier shared the links for the analyses of M1’s profit history and balance sheet strength. Here they are again for convenience: profit history and balance sheet strength.)

In summary, M1 is a telco with insufficient free cash flow to support its dividend, and a weak balance sheet. So, the probability that M1 can sustain its current dividend in the future looks low.

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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.