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Is Nine Dragons Paper (Holdings) Limited (HKG:2689) A Smart Choice For Dividend Investors?

Simply Wall St

Dividend paying stocks like Nine Dragons Paper (Holdings) Limited (HKG:2689) 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.

In this case, Nine Dragons Paper (Holdings) likely looks attractive to investors, given its 8.2% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying Nine Dragons Paper (Holdings) for its dividend, and we'll go through these below.

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SEHK:2689 Historical Dividend Yield, September 6th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Looking at the data, we can see that 40% of Nine Dragons Paper (Holdings)'s profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Nine Dragons Paper (Holdings) paid out 110% of its free cash flow last year, which we think is concerning if cash flows do not improve. Nine Dragons Paper (Holdings) paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Nine Dragons Paper (Holdings) to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is Nine Dragons Paper (Holdings)'s Balance Sheet Risky?

As Nine Dragons Paper (Holdings) has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 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). With net debt of 2.25 times its EBITDA, Nine Dragons Paper (Holdings)'s debt burden is within a normal range for most listed companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 10.45 times its interest expense appears reasonable for Nine Dragons Paper (Holdings), although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of Nine Dragons Paper (Holdings)'s latest financial position, by checking our visualisation of its financial health.

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 Nine Dragons Paper (Holdings)'s dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was CN¥0.052 in 2009, compared to CN¥0.50 last year. Dividends per share have grown at approximately 25% per year over this time. The dividends haven't grown at precisely 25% every year, but this is a useful way to average out the historical rate of growth.

Nine Dragons Paper (Holdings) has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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? It's good to see Nine Dragons Paper (Holdings) has been growing its earnings per share at 30% a year over the past 5 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.

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. First, we like Nine Dragons Paper (Holdings)'s low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. In sum, we find it hard to get excited about Nine Dragons Paper (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 13 analysts we track are forecasting for Nine Dragons Paper (Holdings) for free with public analyst estimates 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%.

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.

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. Thank you for reading.