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.