Get to know the Dividend Safety Ratio

Show me the money! That’s exactly the message when you receive the dividend payment from your equity investments.

The money is real, and a company cannot just pay out dividend based on profit as profit is an opinion, but cash flow is a fact.  A company could borrow money to pay the dividends or dip into its existing cash balance to pay the dividends or sell assets to pay dividends, these methods do not appear sustainable to me in the long run.

Usually dividend investors would like to know how safe is the dividend payment received, you would not want to pin hope on dividends stream which are not sustainable in your quest towards financial independence.

The magic formula that comes in handy will be the free cash flow to dividend cover ratio.

Dividend coverage = free cash flow over dividend payout

Assuming a company generates net operating cash flow of RM100 mil and after taken care of investing outflows i.e. capital expenditure of RM30 mil, there is free cash flow (FCF) of RM70 mil which the company could use to pay off debts, or build up its cash reserves or to fund the dividend payment.

Assuming dividend payout is RM50 mil, the company could easily fund this dividend payment via its RM70 mil FCF without the need to sell assets, or raise debts or tap into existing cash reserves.

The dividend cover translates into a comfortable ratio of 1.4x (RM70 mil FCF / RM50 mil dividend payout), I would be glad if my invested company has a dividend cover of at least 1x.

 

Failing which, there could be a risk of dividend cut if FCF is less than dividend payout on a prolonged basis as a company could not keep borrowing indefinitely to pay dividend amidst finite cash reserves. Moreover, if the company has high dividend payout ratio, insufficient FCF to cover dividend payout might signal potential future dividend cut.

So, make FCF to dividend cover ratio your good friend when you hunt for your income stock! Remember to check the ratio to gauge if the dividend payment is safe!

Impact of Malaysia General Election (GE14) on Investment Portfolio

The world has just witnessed an orderly transition of power in Malaysia following the result of GE14.  A change in federal government after 6 decades!

As an income investor, the ultimate question that cross my mind is,  how would the change in government impact the various sectors? 

1) We have seen the sharp plunge in share prices on stocks whose fortunes are perceived to be linked to various contracts dished out by the previous BN government such as MYEG, Destini, Gamuda etc. Imagine you hold MYEG and the price plunged from RM2.6 before GE to RM0.9 level as at end-May 2018, that is 65% paper loss. I will usually stay out from political linked counters, although certain political linked counters could generate handsome return.

2) With the zerorisation of Goods & Services Tax in June onwards and Sales & Services Tax scheduled to be implemented in September, there will be 3 months of tax holiday, I suspect consumers may ramp up their spending again. Consumers have more income in the pocket to be saved or consumed. Consumer sector will rejoice, if the GST abolishment results in revenue shortfall of around RM20 bil to government coffer, it means additional RM20 bil in the domestic system that could be spent. 

Source: ET Strategic Marketing

Besides, fixing RON95 at a fixed level while RON97 to float, is also a welcome mechanism for most consumers amidst the higher oil prices now. Consumer sectors i.e. Auto sector, Brewery, Apparel makers , Retail Mall REITs will be the key beneficiary, no doubt about it.

3) With toll abolishment manifesto, expect this to be a very gradual development as government will need to balance the manifesto agenda vis-a-vis financial position. If tolls are being abolished, there shall be compensation to toll concessionaire. Stocks that are impacted e..g. Litrak & Gamuda (one of the shareholders of Litrak). Shareholders who invested in Litrak stocks for dividends will need the consider if the toll is being abolished in the interest of the nation, what sort of equity value will accrue to the shareholders?

4) Tenaga Nasional, a monopoly in the domestic electricity distribution business, may be impacted if the new government disagree with the implementation of ICPT (imbalance cost pass through) mechanism. With higher fuel prices & other generation cost, the rising cost will be passed to the consumers if electricity tariff is being increased under ICPT mechanism so that the higher cost will not impact Tenaga Nasional's financials adversely. With new government's objective to address the concerns of rising cost of living, it remains to be seen if the electricity tariff can be increased in June since the tariffs are being reviewed every June and December. If ICPT cannot be implemented, how would TNB shoulder the higher cost? will government provides enough subsidy to assist TNB?

The abovementioned impact is not meant to be exhaustive, the clear winner from my quick thought?

Consumer sectors, higher consumer income will support the sector's earning sustainability and growth moving forward.

Should You Rejoice over 100% Dividend Payout Policy?

2018 valentines day was indeed a happy day for Carlsberg Malaysia shareholders as the board formally announced a new dividend  policy whereby Carlsberg Malaysia will pay 100% of its net profit to shareholders moving forward.

In fact, it has paid average 100% or more of its net profit in the past 3 years (2015 -2017), hence the announcement was basically to formalize the new dividend payout policy.

Can Carlsberg Malaysia afford to pay out 100% of its net profit?

1) It is in net cash position ( cash balance > debt balance) in 2017.

2) Healthy current ratio (current asset > current liabilities) of more than 1x in 2017.

3) Strong free cash flow position ( operating cash flow > capital expenditure) in 2017.

4) Business is relatively stable and not highly cyclical, although subject to seasonality like festive season. When economy is bad, people may even drink more.

5) No material litigation against the company but bear in mind it has RM55 mil of custom duty or tax liability if it crystalize.

Based on the above, it seems like Carlsberg Malaysia is in a position to adopt 100% dividend payout policy. 

   Source: Dividend.com

However, not all is rosy with 100% payout ratio. If a company's profitability declines, there could even be a possibility of dividend cut.

Hence, while shareholders rejoice over the 100% dividend payout policy, close monitoring on its future business performance is still critical to assess if the payout is sustainable over the long run, especially if it pays above 100% of its net profit on prolonged basis.

Should Dividend Investors be Worried on Rising Interest Rate in US?

Dow Jones Industrial Index (DJIA) plunged more than 1,000 points on 8 February 2018 and various media highlighted the concerns on rising inflation plus rising interest rates in US being the cause of the stock market decline.

The decline in global stock market again validate the idea that some investors succumb to herd mentality and swayed by emotions brought by the volatilities in the stock market.

Rising US interest rate will cause US government bond yield to increase (higher bond yield means lower bond prices), thus decrease the attractiveness of dividend yield stocks, hence investor should sell their dividend stocks,, do you agree? 

The above is the statement that you may have read from various media, what happen if we let go of our independent thinking and follow the media? we will be in for a roller coaster ride, not a good idea.

Firstly, dividend investor who aims to live off dividend income, should ignore any short term noises in the stock market. Why is that so?

1) If US inflation and interest rate increase due to stronger underlying economy i.e. low unemployment rate, robust wage growth. Isn't this a good news to equity investor in the long run?

2) If economy performs well and US consumers increase their spending on goods and services, isn't this a good news to equity investor in the long run?

3) If global economy has a synchronized recovery, thus higher inflationary pressure after many years of low interest rate and subdued inflation, isn't this a good news to equity investor in the long run?

4) If better economy translates into better company's profitability, even if dividend payout ratio remains the same, investors will benefit from higher dividend income due to higher dividend per share on the back of higher earning per share, isn't this a good news to equity investor in the long run?

Ultimately the key factor for dividend investor to assess will be the competitive advantage of the business that we are investing in, no doubt higher interest rate may cause increase in cost of borrowings or cost structure and thus impact a company's bottom line, what if the company engages in effective hedging policy or having large portion of fixed rate borrowings or possess pricing power to grow its profitability in the long run amidst higher interest rate environment?

To name a few, If companies such as Procter & Gamble (P&G), Coca Cola, 3M, Colgate Palmolive and Johnson & Johnson (J&J) are able to increase its annual dividend payout in the past 50 over years over various interest rate cycle, really the key focus for income investor is to search and invest in companies with the prospect of increasing its profitability and dividend payout in the long run.

What about the share price?

It will take care of itself for a strong fundamentals company in the long run.