Today we'll take a closer look at Keppel Corporation Limited (SGX:BN4) 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. 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 Keppel. It would not be a surprise to discover that many investors buy it for the dividends. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Keppel paid out 51% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while Keppel pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is Keppel's Balance Sheet Risky?
As Keppel 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. With net debt of 9.33 times its EBITDA, Keppel could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 8.62 times its interest expense appears reasonable for Keppel, although we're conscious that even high interest cover doesn't make a company bulletproof. Adequate interest cover may make the debt look safe, relative to companies with a lower interest cover ratio. However with such a large mountain of debt overall, we're cautious of what could happen if interest rates rise.
Remember, you can always get a snapshot of Keppel'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. Keppel has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was S$0.38 in 2010, compared to S$0.20 last year. This works out to be a decline of approximately 6.3% per year over that time. Keppel's dividend has been cut sharply at least once, so it hasn't fallen by 6.3% every year, but this is a decent approximation of the long term change.
We struggle to make a case for buying Keppel 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. Keppel's earnings per share have shrunk at 18% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
Conclusion
To summarise, shareholders should always check that Keppel'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 think Keppel has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings per share are down, and Keppel's dividend has been cut at least once in the past, which is disappointing. In this analysis, Keppel doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Market movements attest to how highly valued a consistent dividend policy is to one to which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. To that end, Keppel has 5 warning signs (and 1 which shouldn't be ignored) we think you should know about.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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.
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. Thank you for reading.