Yahoo Finance Sembcorp Industries Ltd (SGX:U96) Investors Should Think About This Before Buying It For Its Dividend
Dividend paying stocks like Sembcorp Industries Ltd (SGX:U96) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
While Sembcorp Industries's 1.9% dividend yield is not the highest, we think its lengthy payment history is quite interesting. There are a few simple ways to reduce the risks of buying Sembcorp Industries for its dividend, and we'll go through these below.
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Payout ratios
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Sembcorp Industries paid out 22% of its profit as dividends, over the trailing twelve month period. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Sembcorp Industries paid out 57% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's positive to see that Sembcorp Industries's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Sembcorp Industries's Balance Sheet Risky?
As Sembcorp Industries has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Sembcorp Industries has net debt of 6.70 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.39 times its interest expense is starting to become a concern for Sembcorp Industries, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.
We update our data on Sembcorp Industries every 24 hours, so you can always get our latest analysis of its financial health, here.
Dividend Volatility
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Sembcorp Industries's dividend payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was S$0.11 in 2010, compared to S$0.04 last year. The dividend has shrunk at around 9.6% a year during that period. Sembcorp Industries's dividend hasn't shrunk linearly at 9.6% per annum, but the CAGR is a useful estimate of the historical rate of change.
A shrinking dividend over a ten-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Sembcorp Industries's EPS have fallen by approximately 16% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Sembcorp Industries's earnings per share, which support the dividend, have been anything but stable.
Conclusion
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Above all, we're glad to see that Sembcorp Industries pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. Earnings per share are down, and Sembcorp Industries's dividend has been cut at least once in the past, which is disappointing. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Sembcorp Industries out there.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
