3 Concerns That I Have With M1 Ltd’s High Dividend Yield Of 6.7%

M1 Ltd  (SGX: B2F) is an easily recognisable company in Singapore, given that it’s our island nation’s third largest operational telco.

Over the last 12 months, M1 has seen its stock price fall by 19.0% to S$1.71 currently. At S$1.71, the telco has a trailing dividend yield of 6.7%, 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 6.7% may look sweet to dividend investors. But, there are risks that investors should be aware of. In this article, I will share 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, M1 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 26% from S$179 million to S$133 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, M1’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 M1, it has seen its dividend per share decline in every year starting from 2015, as the table below shows:

Source: S&P Global Market Intelligence

From 2014 to 2017, M1 has lowered its dividend by a total of 40%.

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 M1, it generated only S$0.116 per share in free cash flow, which is just a hair’s breadth higher than its dividend of S$0.114 per share for the same year. These numbers give a free cash flow payout ratio of 98%.

M1 is currently paying a dividend within its means. But, there’s basically no room for error. And, if M1’s profitability begins to fall while capital expenditures increase in the face of more competition, M1’s current dividend may not be sustainable.

A Foolish bottom line

In sum, M1’s current 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 the high payout ratio.

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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.