Dividend paying stocks like Greentown China Holdings Limited (HKG:3900) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
A slim 2.7% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Greentown China Holdings could have potential. There are a few simple ways to reduce the risks of buying Greentown China Holdings for its dividend, and we'll go through these below.
SEHK:3900 Historical Dividend Yield, February 13th 2020
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. Although it reported a loss over the past 12 months, Greentown China Holdings currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.
Last year, Greentown China Holdings paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Greentown China Holdings's Balance Sheet Risky?
Given Greentown China Holdings is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. 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). Greentown China Holdings has net debt of 5.21 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. With EBIT of 494.10 times its interest expense, Greentown China Holdings's interest cover is quite strong - more than enough to cover the interest expense. Despite a decent level of interest cover, shareholders should remain cautious about the high level of net debt. Rising rates or tighter debt markets have a nasty habit of making fools of highly-indebted dividend stocks.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Greentown China Holdings's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was CN¥0.17 in 2010, compared to CN¥0.23 last year. Dividends per share have grown at approximately 3.2% per year over this time. Greentown China Holdings's dividend payments have fluctuated, so it hasn't grown 3.2% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Greentown China Holdings's earnings per share have shrunk at 16% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
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. We're a bit uncomfortable with Greentown China Holdings paying a dividend while loss-making, especially since the dividend was also not well covered by free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. In this analysis, Greentown China Holdings doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 3 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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.
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