Singapore Technologies Engineering Ltd (SGX: S63) is a conglomerate specialising in the aerospace, electronics, land systems and marine sectors. The group serves customers in the defence, government and commercial segments in over 100 countries.
ST Engineering shares closed at S$3.57 apiece yesterday. At that price, the company had a dividend yield of 4.2%. 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 less than 4% on the same day.
With a dividend yield that is higher than that of the stock market in general, a question naturally arises: Is ST Engineering’s dividend sustainable going forward?
To find out if ST Engineering’s dividend is sustainable, we have to 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 ST Engineering’s past few financial years (its fiscal year ends on 31 December each year):Source: S&P Global Market Intelligence
Free cash flow is cash that a firm can use to dish out dividends to shareholders, buy back its shares, make acquisitions, or strengthen its balance sheet, among other things.
ST Engineering’s free cash flow had fallen from S$647.7 million in 2013 to S$491.1 million in 2017. During the same period, its dividend payment had increased. In 2013, it paid S$0.07 per share in total ordinary dividend, and this figure had risen to S$0.15 per share in 2017.
The dividend payout ratio is calculated by taking the earnings per share divided by the dividend per share. This ratio shows the percentage of a company’s earnings that is 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 100% indicates that the company is paying out more in dividends than it makes in net profit, making the dividends unstainable.
ST Engineering’s dividend payout ratio had climbed from 37.7% in 2013 to 91.4% in 2017. The latest payout ratio is still below 100% though, leaving a slight margin of safety. But it’s too close for comfort for me.
The Foolish takeaway
ST Engineering’s free cash flow had been coming down for the past five years, while its dividend payment and dividend payout ratio had increased.
I believe ST Engineering would be able to sustain its total ordinary dividend of S$0.15 per share going forward – without dipping into its cash reserves – if its free cash flow is equal to or more than the 2017 free cash flow.
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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.