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Would Sunfonda Group Holdings Limited (HKG:1771) Be Valuable To Income Investors?

Simply Wall St

Is Sunfonda Group Holdings Limited (HKG:1771) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

In this case, Sunfonda Group Holdings likely looks attractive to dividend investors, given its 6.4% dividend yield and five-year payment history. It sure looks interesting on these metrics - but there's always more to the story . Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

SEHK:1771 Historical Dividend Yield, November 4th 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. Sunfonda Group Holdings paid out 19% of its profit as dividends, over the trailing twelve month period. We'd say its dividends are thoroughly covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Sunfonda Group Holdings paid out 39% as dividends, suggesting the dividend is affordable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Sunfonda Group Holdings's Balance Sheet Risky?

As Sunfonda 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 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. Sunfonda Group Holdings has net debt of 3.18 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.01 times its interest expense is starting to become a concern for Sunfonda Group Holdings, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of Sunfonda Group Holdings's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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. Sunfonda Group Holdings has been paying a dividend for the past five years. During the past five-year period, the first annual payment was CN¥0.05 in 2014, compared to CN¥0.061 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.0% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

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 not great to see that Sunfonda Group Holdings's have fallen at approximately 5.5% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

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. It's great to see that Sunfonda Group Holdings is paying out a low percentage of its earnings and cash flow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Sunfonda Group Holdings out there.

Now, if you want to look closer, it would be worth checking out our free research on Sunfonda Group Holdings management tenure, salary, and performance.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.