The dividend yield of a company tells us nothing about the sustainability of its dividends in the long run. A company that is yielding say, 4%, may or may not be able to sustain the 4% yield the following year, assuming there?s no change in the share price.
To find out if the dividend dished out by a company is sustainable, we have to look at other aspects of the company instead. By the word ?sustainable,? I mean that the company?s dividends can be paid from the cash generated from daily operations, and not from the accumulated cash balance over…
The dividend yield of a company tells us nothing about the sustainability of its dividends in the long run. A company that is yielding say, 4%, may or may not be able to sustain the 4% yield the following year, assuming there’s no change in the share price.
To find out if the dividend dished out by a company is sustainable, we have to look at other aspects of the company instead. By the word “sustainable,” I mean that the company’s dividends can be paid from the cash generated from daily operations, and not from the accumulated cash balance over the years or from one-off gains.
With these in mind, let’s find out if SIA Engineering Company Ltd’s (SGX: S59) dividends are sustainable. The firm ended the day at S$3.18 per share and sports a dividend yield of 5.7%, including special dividends. As a comparison, the STI ETF (SGX:ES3), an exchange-traded fund that tracks the fundamentals of the Straits Times Index (SGX: ^STI), yields just 2.9%.
The table below shows a summary of some of the key figures from SIA Engineering’s past few financial years (its financial year ends on 31 March):
Source: SIA Engineering Company Ltd’s Annual Reports
Free Cash Flow
Usually, the more the free cash flow that is generated over the years, the higher the chance of a company paying the cash out as dividends to shareholders.
It can be seen from the table above that free cash flow has been declining from S$101.8 million in FY2012/13 to S$93.5 million in FY2016/17. The falling free cash flow is a concern.
Due to timing differences, the dividends paid for each year may not translate to the total dividends paid per share multiplied by the number of shares outstanding.
Even then, it looks like SIA Engineering has been paying much more dividends than the free cash flow could afford.
Dividend Payout Ratio
The dividend payout ratio tells investors what percentage of a company’s earnings are paid out yearly as a dividend. Generally, if a company has a high payout ratio, it might not be able to continue paying out the same dividend if profits drop in the future. Also, a ratio of above one indicates that the company is paying out more in dividends than it gets in net income, which is unsustainable.
As seen from the table above, the dividend payout ratios of SIA Engineering have been around 0.61 to 1.05.
In FY2016/17, the firm paid out a special dividend of 5.0 cents and saw a one-off gain due to the divestment of its 10% stake in Hong Kong Aero Engine Services Ltd. Upon adjustment for the special dividend and one-off gain, the payout ratio shoots up to 0.85.
Total Dividends Paid Per Share
Just like the decline in free cash flow, almost in a similar fashion, total dividends paid per share has fallen from 22 cents in FY2012/13 to 18 cents in FY2016/17.
A Foolish Takeaway
It looks like the dividends from SIA Engineering might not be sustainable with the declining free cash flow, dividends paid being higher than the free cash flow, and high dividend payout ratio.
However, there is no straightforward answer as to whether SIA Engineering can maintain its dividends without dipping its hands into its cash coffers, as there are several moving parts to the business. A study of the company’s financial history is important and informative, but more work needs to be done beyond that before any investing decision can be made.
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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 Sudhan P owns units in STI ETF.