Dividend paying stocks like China Communications Construction Company Limited (HKG:1800) 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 high yield and a long history of paying dividends is an appealing combination for China Communications Construction. We’d guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. In the last year, China Communications Construction paid out 19% of its profit as dividends. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, China Communications Construction paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is China Communications Construction’s Balance Sheet Risky?
As China Communications Construction 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 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. China Communications Construction has net debt of 6.51 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. China Communications Construction has interest cover of more than 12 times its interest expense, which we think is quite strong. 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.
We update our data on China Communications Construction every 24 hours, so you can always get our latest analysis of its financial health, here.
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. For the purpose of this article, we only scrutinise the last decade of China Communications Construction’s dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was CN¥0.098 in 2010, compared to CN¥0.23 last year. Dividends per share have grown at approximately 8.9% per year over this time.
Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend’s purchasing power over the long term. Earnings have grown at around 9.6% a year for the past five years, which is better than seeing them shrink! With a decent amount of growth and a low payout ratio, we think this bodes well for China Communications Construction’s prospects of growing its dividend payments in the future.
We’d also point out that China Communications Construction issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental – it’s hard to grow dividends per share when new shares are regularly being created.
To summarise, shareholders should always check that China Communications Construction’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 China Communications Construction’s low dividend payout ratio, although we’re a bit concerned that it paid out a substantially higher percentage of its free cash flow. Next, growing earnings per share and steady dividend payments is a great combination. China Communications Construction has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.
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 China Communications Construction for free with public analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
If you spot an error that warrants correction, please contact the editor at email@example.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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