The Motley Fool

Challenger Technologies Limited Is Yielding Around 7% Now: Is the Dividend Sustainable?

Challenger Technologies Limited (SGX: 573) is an operator of the Challenger chain of information technology (IT) retail stores, and the online IT marketplace, Currently, the company has a total of 38 stores, consisting of one flagship Challenger store, 25 Challenger superstores, and 12 small format stores.

Shares in the company closed last Thursday at S$0.48 apiece. At that price, Challenger has a high dividend yield of 6.9%. In contrast, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which can be taken as a proxy for the local stock market, had a yield of just 3% on 14 June 2018.

With such a high dividend yield, a question naturally arises: Is Challenger’s dividend sustainable going forward?

To find out if the dividend of Challenger is sustainable, we can look at its free cash flow and dividend payout ratio instead of its dividend yield. By “sustainable,” I mean that the company’s dividends can be paid from the cash generated from its daily operations, and not from its accumulated cash balance over the years.

The table below shows a summary of some of the key figures from Challenger’s past few financial years (its financial year ends on 31 December each year):Source: Challenger Technologies’ earnings reports and author’s calculations

It can be seen that Challenger’s free cash flow had improved from S$12.7 million in 2013 to S$17.7 million in 2017. With the higher free cash flow, the company’s dividend had also increased from 2.52 cents per share to 3.30 cents per share over the same time frame. Generally, the more free cash flow a company can generate, the higher the company’s chances of paying a dividend to its shareholders. Challenger’s improving free cash flows are supporting the growth in its dividends over the years.

Now, let’s turn our attention to Challenger’s dividend payout ratio, which had climbed from 0.51 in 2013 to 0.70 in 2017. The dividend payout ratio measures the percentage of a company’s earnings that are paid out yearly as a dividend.

Even though Challenger paid out 70% of its earnings as a dividend in 2017, it still has room to increase its dividend, in my opinion. This is because on top of the relatively low payout ratio, the company’s total dividend in 2017 of 3.3 cents is just 64% of the free cash flow for the year.

The Foolish takeaway

Challenger’s dividend yield of around 7% is higher than that of some real estate investment trusts (REITs) listed on the Singapore stock market. The company’s high yield is undoubtedly enticing, but investors should not invest in any company based solely on its dividend yield – attention needs to be paid to whether the dividend is sustainable. A company’s free cash flow and dividend payout ratio helps show a more holistic picture of the sustainability of a company’s dividend.

With its growing free cash flow, and with a dividend payout ratio of just 70%, I believe the dividend from Challenger is highly likely to be sustained going forward.

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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 doesn’t own shares in any companies mentioned.