Don't Race Out To Buy China Shenhua Energy Company Limited (HKG:1088) Just Because It's Going Ex-Dividend

It looks like China Shenhua Energy Company Limited (HKG:1088) is about to go ex-dividend in the next two days. The ex-dividend date is commonly two business days before the record date, which is the cut-off date for shareholders to be present on the company's books to be eligible for a dividend payment. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. This means that investors who purchase China Shenhua Energy's shares on or after the 26th of June will not receive the dividend, which will be paid on the 20th of August.

The company's upcoming dividend is CN¥2.26 a share, following on from the last 12 months, when the company distributed a total of CN¥2.26 per share to shareholders. Looking at the last 12 months of distributions, China Shenhua Energy has a trailing yield of approximately 7.2% on its current stock price of HK$34.35. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether China Shenhua Energy can afford its dividend, and if the dividend could grow.

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Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Its dividend payout ratio is 76% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. It could become a concern if earnings started to decline. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. The company paid out 91% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Companies usually need cash more than they need earnings - expenses don't pay themselves - so it's not great to see it paying out so much of its cash flow.

China Shenhua Energy paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were China Shenhua Energy to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

View our latest analysis for China Shenhua Energy

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're encouraged by the steady growth at China Shenhua Energy, with earnings per share up 7.5% on average over the last five years. Earnings have been growing at a steady rate, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last 10 years, China Shenhua Energy has lifted its dividend by approximately 9.5% a year on average. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

Has China Shenhua Energy got what it takes to maintain its dividend payments? Earnings per share have grown somewhat, although China Shenhua Energy paid out over half its profits and the dividend was not well covered by free cash flow. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with China Shenhua Energy. To that end, you should learn about the 2 warning signs we've spotted with China Shenhua Energy (including 1 which makes us a bit uncomfortable).

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.