Data on this article can be found in the Google Spreadsheet here >>
When you sometimes buy a stock for dividends, you look only at the current yield of the stock and take it for granted that it is like a fixed desposit where the interest rate fluctuates little.
The common psychological thinking is that the stock IS EXPECTED to maintain the dividend payout, but that isn’t usually the case.
Dividend per share per year (DPS) fluctuates.
In a growth company, what start off as a small DPS relative to share price might grow and grow so much so that its dividend yield is eventually higher or equivalent to some stock that pays high yield. MacDonald’s and Pepsi comes to mind. Their dividends just grow and grow for 20 years plus. Great investment.
In a mature company, the dividend payouts tend to fluctuate. When business is good they pay out more than average, else they pay out less. In Singapore, most of the companies such as UOB, DBS and SembCorp is like that.
Then you have your dividend companies that you buy for its consistent cashflow, companies such as Telcos, Utilities, REITs, MLP. Their DPS is consistent and makes then easy to value. A trend that we see is that these companies find it very difficult to value create and grow their profits and cashflow with the existing resources.As such DPS tend to stagnate or in difficult times go down. So what start off as a high yield at your purchase price ends up big very small.
For stocks that consistently pays dividends more or less, their share price will reflect the expectations of investors and this affects you as an investor both trying to get in or already vested in the company.
Case Study: Starhub
I decide to use Starhub since it is one of my vested holdings and recently they announce a first quarter results that is less than satisfactory [Report here >>].
Starhub is a telecommunications company based in Singapore and listed on the SGX. The dividend guidance given is that they will maintain a minimum DPS of SGD $0.05 per quarter or SGD $0.20 per year.
Based on my highest purchase share price $2.37, $0.20/$2.37 comes up to 8.4% yield on cost. That’s not a bad yield, since I bought Starhub after understanding that telecommunications stocks’ business economics enable them to generate consistent operating cashflow which makes dividend payout predictable.
At an EV/EBITDA of nearly 6 times, the valuation looks just about right.
For stocks like this we don’t expect much surprises, but history have taught us that companies that have all the while generate consistent earnings will faced business pressures that changes the profitability of what you might once evaluated as strong. Competition, Substitutes and Mismanagement are some causes of this.
Starhub’s results in the first quarter resulted in the profits being halved in the first quarter. This impacts the operating cashflow and makes investors question whether they can pay out the SGD $0.20 dividend.
To make understanding easier i have come up with 2 Dividend Sensitivity Tables found on my Google Spreadsheet under Dividend Sensitivity.
So currently at SGD$0.20 payout, the actual dividend payout on Starhub’s cashflow statement is SGD $342 mil. You will see here my purchase price is somewhere between 2.30 and 2.40.
How does Starhub’s weak operating cashflow affects the dividend? In the case of most dividend stocks that $342 mil is paid out from Operating Cashflow after spending on Capital Expenditure. So a smaller Operating Cashflow due to cost of goods sold increasing or an increase in capital expenditure would mean that Starhub will have difficulty in meeting that $342 mil.
What this first table here shows is that if the operating scenario persist, Starhub might have difficulty meeting that minimum dividend guidance. They would have to lower that DPS if they want to maintain good practice.
Using this table, we will see that when DPS is reduced from $0.20 down to $0.16, the yield on cost for my $2.37 purchase fall to 6.67%. Hey 6.67% is still quite good isn’t it?
A reduction of payout to $0.16 cents which is around $0.04 per quarter represents a 20% reduction in dividend payout and a much much more conservative amount to give out. At $342 mil they can barely make it this year 2010. And likely they would have to pay out from their existing cash holdings or get bonds and debts to fund this.
The market’s demand for a specific yield
But lets say that you die die want around 8% yield. Your choice as a rational investor will be to sell this stock and buy another one yielding 8%.
In a certain way you will see the market react accordingly to this yield that they want. For the kind of risk I invest in Starhub, I demand this amount of compensation. And if Starhub is unable to provide that amount of compensation in the form of dividends, the share price theoretically have to be adjusted downwards to meet my 8% yield that i demand.
So on the next day of the earnings release, coupled with the market turmoil the stock have gone downwards. I believe word got out even before that that’s why 2 days ago there was a massive sell down already.
For an investor looking to add to current holdings or an opportunistic investor, how far can starhub fall?
Here we have the second table, a slightly different table. We have the yield you demanded, or market demanded, depending on how you look at it versus the difference in DPS.
So in our case, if the current DPS is $0.20 and the market demand is around 8% yield, the fair value now should be $2.50, which is higher than what i paid for.
So when we received news like the profits are affected, the market is thinking that Starhub cannot pay that $0.20 anymore. The DPS will have to go down either to $0.18 or even as low as $0.14, the market doesn’t know but the market is taking it that its going to be lower.
So currently the share price is around $2.15, one way of looking at it is that the market is taking it that Starhub can safely pay $0.17
The values thrown around by brokerage houses downgrades were SGD$1.88 to SGD $2.00. If the market demanded yield is 8% then the market seems to be saying that the safe DPS is around $0.15 to $0.16 cents.
You guys can play with the permutations accordingly all day. Probably can use a demand for 9% yield and if you need to find out how much is $0.14 DPS on balance sheet check out the previous table in my spreadsheet.
Valuing on the upside
You can also view it the other way round. Lets say the market demand is 8% yield and they are currently paying $0.16. So if Starhub increase its dividend payout to $0.22 cents, it will mean that the supposed fair value is $2.75. depending on what is the current share price, you can judge roughly whether the stock is under or overvalue.
The problem with valuing it this way
The problem is that the market yield demanded is unknown and can vary. It is to me a perceived number that the total market participants are looking for. So it could be 8%, it could be 9%.
This form of evaluation is best used as an estimation.
How i would evaluate Starhub at May 2010
While i don’t know how the full year operating cashflow will turn out we take it that there will be a revised down of operating cashflow. Capital Expenditure will be 14% of operating revenue which should come up to SGD 300mil.
To pay out the current $0.20 it will mean that operating cashflow need to be $300mil + $342mil = $642 mil. Divide by 4 and its $160mil which is roundly the operating cashflow this Q1.
They are barely able to make it.
A $0.18 dividend will mean a 10% reduction in payout and $0.16 a 20% reduction. This year i fully expect 20 cent dividend since the guidance is given. But should competition be as tough as now and not abiding, a revised payout to $0.16 might be more conservative.
At current price of $2.15 the payout this year will be around 9.25% which is darn good. A future reduction in payout if you buy at current price will be around 7.40%. Which is pretty good and above average as well.
Even if you take dividend payout all the way down to $0.14 the yield is around 6.50% which is still higher than SingPost, Parkway Life REIT which are the safe stocks.
So if you are holding this stock, evaluate the sustainability of operating cashflow, whether a telecommunication stock like Starhub can pay a reduce operating cashflow of $570 mil.
The problem is if you are trying to add on how low should you wait for? The brokerage houses are throwing numbers like $1.90-$2.05.
Most likely every one is looking at a market demand yield of around 8-9% and a 10% reduction in DPS. In that case should the DPS be $0.18 the share price is either $2.00 for 9% or $2.25 for 8%.
Currently we are at $2.19 so a market demand of 8% and $0.18 DPS looks likely. This shows that if mkt demand is 8% we are fairly value at $2.19. But if its 9% they are demanding Starhub needs to fall until $2.00.
So that is another 10% fall. In recent times, the strongest support or low have been $1.88, which is right around what the brokerage houses are touting.
The 200 day MA is at $2.14 so if you are planning to hold this, when it gets down to $2.14 is a good time to add, if it goes down further, I would advise to wait for it to turn up before adding.
As a current investor if it breaches $2.14 you might want to play it cautious according to your rules as what is good might get cheaper. you might want to look at lighten your Starhub holdings and add it below the 200day ma when it turns up. It has shown that when the 50day ma cutting the 200day ma to the downside, it is quite longterm bearish.