Dividend paying stocks like The Hongkong and Shanghai Hotels, Limited (HKG:45) 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.
While Hongkong and Shanghai Hotels’s 1.9% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.
Click the interactive chart for our full dividend analysis
SEHK:45 Historical Dividend Yield April 27th 2020
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. 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. In the last year, Hongkong and Shanghai Hotels paid out 43% 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. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Hongkong and Shanghai Hotels’s cash payout ratio last year was 23%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It’s positive to see that Hongkong and Shanghai Hotels’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Hongkong and Shanghai Hotels’s Balance Sheet Risky?
As Hongkong and Shanghai Hotels 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. Hongkong and Shanghai Hotels has net debt of 5.19 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
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 5.72 times its interest expense appears reasonable for Hongkong and Shanghai Hotels, 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.
Consider getting our latest analysis on Hongkong and Shanghai Hotels’s financial position here.
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. Hongkong and Shanghai Hotels has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was HK$0.14 in 2010, compared to HK$0.13 last year. Dividend payments have shrunk at a rate of less than 1% per annum over this time frame.
When a company’s per-share dividend falls we question if this reflects poorly on either external business conditions, or the company’s capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Hongkong and Shanghai Hotels’s EPS have fallen by approximately 17% per year during 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
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Firstly, we like that Hongkong and Shanghai Hotels has low and conservative payout ratios. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. Ultimately, Hongkong and Shanghai Hotels comes up short on our dividend analysis. It’s not that we think it is a bad company – just that there are likely more appealing dividend prospects out there on this analysis.
It’s important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. However, there are other things to consider for investors when analysing stock performance. To that end, Hongkong and Shanghai Hotels has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.