Three Things You Should Check Before Buying China Coal Energy Company Limited (HKG:1898) For Its Dividend

Dividend paying stocks like China Coal Energy Company Limited (HKG:1898) 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. 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.

With China Coal Energy yielding 3.1% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding China Coal Energy for its dividend, and we’ll focus on the most important aspects below.

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SEHK:1898 Historical Dividend Yield, August 15th 2019
SEHK:1898 Historical Dividend Yield, August 15th 2019

Payout ratios

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 Coal Energy paid out 29% 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. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. China Coal Energy’s cash payout ratio in the last year was 39%, which suggests dividends were well covered by cash generated by the business. 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 China Coal Energy’s Balance Sheet Risky?

As China Coal Energy 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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). China Coal Energy is carrying net debt of 3.75 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

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 Coal Energy has EBIT of 7.03 times its interest expense, which we think is adequate.

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. China Coal Energy has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was CN¥0.15 in 2009, compared to CN¥0.078 last year. The dividend has shrunk at around 6.6% a year during that period. China Coal Energy’s dividend hasn’t shrunk linearly at 6.6% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying China Coal Energy for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it’s even more important to see if EPS are growing. China Coal Energy’s earnings per share have been essentially flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company’s dividends could be eroded by inflation. China Coal Energy is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?

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. Firstly, we like that China Coal Energy has low and conservative payout ratios. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. Overall we think China Coal Energy is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 11 China Coal Energy analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.