Read This Before Buying Chip Eng Seng Corporation Ltd (SGX:C29) For Its Dividend
Is Chip Eng Seng Corporation Ltd (SGX:C29) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.
With a nine-year payment history and a 5.8% yield, many investors probably find Chip Eng Seng intriguing. We'd agree the yield does look enticing. There are a few simple ways to reduce the risks of buying Chip Eng Seng 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. 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. In the last year, Chip Eng Seng paid out 37% 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. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Chip Eng Seng 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. It's positive to see that Chip Eng Seng'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 Chip Eng Seng's Balance Sheet Risky?
As Chip Eng Seng 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 a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). Chip Eng Seng has net debt of 9.49 times its earnings before interest, tax, depreciation and amortisation (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 2.69 times its interest expense, Chip Eng Seng's interest cover is starting to look a bit thin. Low interest cover and high debt can create problems right when the investor least needs them. We're generally reluctant to rely on the dividend of companies with these traits.
We update our data on Chip Eng Seng every 24 hours, so you can always get our latest analysis of its financial health, here.
Dividend Volatility
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. The first recorded dividend for Chip Eng Seng, in the last decade, was nine years ago. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past nine-year period, the first annual payment was S$0.03 in 2010, compared to S$0.04 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.2% a year over that time.
Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn't want to rely on this dividend too much.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Chip Eng Seng's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.
Conclusion
To summarise, shareholders should always check that Chip Eng Seng's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we like Chip Eng Seng's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Overall, Chip Eng Seng falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Now, if you want to look closer, it would be worth checking out our free research on Chip Eng Seng management tenure, salary, and performance.
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.
