Dividend paying stocks like China SCE Group Holdings Limited (HKG:1966) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
With a nine-year payment history and a 5.5% yield, many investors probably find China SCE Group Holdings intriguing. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding China SCE Group Holdings for its dividend, and we'll focus on the most important aspects below.
SEHK:1966 Historical Dividend Yield, September 29th 2019
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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, China SCE Group Holdings paid out 26% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while China SCE Group Holdings pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is China SCE Group Holdings's Balance Sheet Risky?
As China SCE Group Holdings 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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). China SCE Group Holdings has net debt of 5.98 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. China SCE Group Holdings has interest cover of more than 12 times its interest expense, which we think is quite strong. Adequate interest cover may make the debt look safe, relative to companies with a lower interest cover ratio. However with such a large mountain of debt overall, we're cautious of what could happen if interest rates rise.
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. The first recorded dividend for China SCE Group Holdings, in the last decade, was nine years ago. It's good to see that China SCE Group Holdings has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was CN¥5.65 in 2010, compared to CN¥0.18 last year. This works out to a decline of approximately 97% over that time.
A shrinking dividend over a nine-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
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see China SCE Group Holdings has grown its earnings per share at 26% per annum over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.
We'd also point out that China SCE Group Holdings issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.
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. China SCE Group Holdings has a low payout ratio, which we like, although it paid out virtually all of its generated cash. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In sum, we find it hard to get excited about China SCE Group Holdings from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 8 analysts we track are forecasting for China SCE Group Holdings for free with public analyst estimates for the company.
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