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3 Reasons Dividend Investors Should Be Wary Of StarHub Ltd’s High Dividend Yield

StarHub Ltd (SGX: CC3) is a company that probably needs no introduction, given that it is one of Singapore’s main operational telcos.

Over the last 12 months, StarHub has seen its stock price fall by 18.0% to S$2.33 currently. At S$2.33, the telco has a trailing dividend yield of 6.9%, which is more than twice the SPDR STI ETF’s (SGX: ES3) yield of 2.9%. The SPDR STI ETF is an exchange-traded fund that tracks the fundamentals of our local stock market benchmark, the Straits Times Index (SGX: ^STI).

The high dividend yield of 6.9% that StarHub sports may look sweet to dividend investors. But, there are risks that investors should be aware of. In this article, I will point out three of them.

The first risk: Lower profits

One important criteria that dividend investors should focus on in assessing a stock is how well its underlying business has performed. A good track record of growth will provide assurance that the company has a high likelihood of being able to sustain its business growth, and by extension, its dividend payments.

Unfortunately, StarHub has not demonstrated the above-mentioned qualities, at least in the last two years. From 2015 to 2017, the telco’s net profit has fallen by 33% from S$372 million to S$250 million.

Furthermore, there is the risk of heightened competition. In late 2016, the Australia-based TPG Telecom was awarded Singapore’s fourth telco license. TPG Telecom announced last month that it expects to launch its service here in the second half of this year. As such, StarHub’s business may continue to face challenges in the foreseeable future.

The second risk: Lower dividends

Another key criterion that dividend investors should look for when investing in a company is its track record in paying a dividend. The key here is to look for stable – or even better, growing – dividends over time.

In the case of StarHub, it had a good record of maintaining its dividend at S$0.20 per share from 2010 to 2016. But in 2017, it lowered its dividend to S$0.16 per share.

The third risk: Inadequate free cash flow per share

In general, for a company to be able to pay a dividend in a sustainable manner, its business must be able to generate cash, after paying its bills and investing in the business to maintain the current state of affairs, that is at the very least on par with its dividend. In finance parlance, the leftover cash is known as free cash flow.

So, the idea here is pretty straight forward: It’s not sustainable over the long run for a company to pay a dividend that is higher than the free cash flow it generates.

Coming to StarHub, the telco generated only S$0.127 per share in free cash flow in 2017, which is lower than its dividend of S$0.16 per share. In fact, the company’s free cash flow per share of S$0.106 in 2016 was also dwarfed by its dividend of S$0.20 per share.

In the short run, StarHub’s strong balance sheet gives it some cushion in maintaining its dividend. On the point about the company’s strong balance sheet, the telco had a net debt to EBITDA (earnings before interest, taxes, depreciation, and amortisation) ratio of just 1.0 at the end of 2017; many other telcos around the world sport ratios of 3 to 4. But, unless StarHub can improve its free cash flow on a sustained basis, there’s a high chance its current dividend will be lowered over the long run.

A Foolish bottom line

In sum, StarHub’s high dividend yield at the moment may be tempting to dividend investors. But, they must take into account the risks involved, such as the company’s falling profits and dividend, and inadequate free cash flow in relation to its dividend paid.

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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.