Is China Gas Holdings Limited (HKG:384) A Smart Pick For Income Investors?

Today we'll take a closer look at China Gas Holdings Limited (HKG:384) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

A 1.6% yield is nothing to get excited about, but investors probably think the long payment history suggests China Gas Holdings has some staying power. Some simple analysis can reduce the risk of holding China Gas Holdings for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on China Gas Holdings!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. China Gas Holdings paid out 27% of its profit as dividends, over the trailing twelve month period. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher 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. China Gas Holdings paid out 217% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. China Gas 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 China Gas Holdings to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is China Gas Holdings's Balance Sheet Risky?

As China Gas Holdings 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 Gas Holdings has net debt of 2.32 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

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 8.64 times its interest expense appears reasonable for China Gas Holdings, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of China Gas 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. For the purpose of this article, we only scrutinise the last decade of China Gas Holdings'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 HK$0.014 in 2010, compared to HK$0.44 last year. Dividends per share have grown at approximately 41% per year over this time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It's good to see China Gas Holdings has been growing its earnings per share at 26% a year over the past five 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.

We'd also point out that China Gas Holdings issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

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. China Gas Holdings has a low payout ratio, which we like, although it paid out virtually all of its generated cash. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Overall we think China Gas Holdings is an interesting dividend stock, although it could be better.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 1 warning sign for China Gas Holdings that investors need to be conscious of moving forward.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.