Could Lai Sun Development Company Limited (HKG:488) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
With a 1.3% yield and a five-year payment history, investors probably think Lai Sun Development looks like a reliable dividend stock. A 1.3% yield is not inspiring, but the longer payment history has some appeal. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
SEHK:488 Historical Dividend Yield April 23rd 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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Although it reported a loss over the past 12 months, Lai Sun Development 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, Lai Sun Development paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Lai Sun Development's Balance Sheet Risky?
Given Lai Sun Development 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 quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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. Lai Sun Development has net debt of 41.70 times its EBITDA, which we think carries substantial risk if earnings aren't sustainable.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of less than 1 times its interest expense, Lai Sun Development's financial situation is potentially quite concerning. Readers should investigate whether it might be at risk of breaching the minimum requirements on its loans. 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.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the data, we can see that Lai Sun Development has been paying a dividend for the past five years. During the past five-year period, the first annual payment was HK$0.13 in 2015, compared to HK$0.11 last year. The dividend has shrunk at around 2.9% a year during that period. Lai Sun Development's dividend has been cut sharply at least once, so it hasn't fallen by 2.9% every year, but this is a decent approximation of the long term change.
When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Lai Sun Development has grown its earnings per share at 11% per annum over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.
Conclusion
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. It's a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. 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. With this information in mind, we think Lai Sun Development may not be an ideal dividend stock.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 1 warning sign for Lai Sun Development that investors should know about before committing capital to this stock.
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.
