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Chow Tai Fook Jewellery Group Ltd (SEGK:1929) is a widely-recognised jewellery retailer that was founded in 1929 (interestingly enough, its ticker symbol is the same number). Chow Tai Fook’s shares closed at HK$7.75 on 21 June 2019. At that share price, it had a dividend yield of 8.4%. The dividend yield looks appealing for income investors but is it sustainable?
Peeling back the gold layers
The dividend yield of a company doesn’t tell us anything about its sustainability. To know if a company’s dividend is sustainable, we have to look beyond its dividend yield and examine its free cash flow and dividend payout ratio.
The table below shows a summary of some of the key figures from Chow Tai Fook’s past five financial years, which ended on 31 March each year:
|Free cash flow (HK$’ million)||2,764||10,690||1,989||3,019||4,100|
|Net debt (HK$’ million)||6,611||1,432||2,066||5,314||10,428|
|Full-year dividend payment (HK$’ million)||2,800||1,600||1,600||2,700||3,500|
|Total dividend payment (HK$’ million)||2,800||8,000||5,100||5,700||6,500|
|Full-year dividend payout ratio||51.3%||54.4%||52.3%||66.0%||76.5%|
|Full-year dividend per share (HK$)||0.28||0.16||0.16||0.27||0.35|
|Special dividend per share (HK$)||0.00||0.64||0.35||0.30||0.30|
|Total dividend per share (HK$)||0.28||0.80||0.51||0.57||0.65|
Source: Chow Tai Fook annual reports; author’s calculations
From FY2015 to FY2019, Chow Tai Fook’s free cash flow has risen from HK$2.8 billion to HK$4.1 billion. However, the growth wasn’t smooth, with free cash flow falling to a low of HK$2.0 billion in FY2017.
It’s not surprising that the total dividend fell in that year too. Free cash flow is cash that a company can use to dish out dividends to shareholders, buy back its shares, make acquisitions, re-invest into its business, and pay off loans.
Dividend payout ratio and sustainability
The dividend payout ratio shows the percentage of a company’s earnings that are paid out yearly as a dividend. I prefer companies that keep their dividend payout ratio to be below 100% because it leaves some room for error and also for dividend increases in the future.
The full-year dividend payout ratio for the jewellery group has ranged from 51% to 77%, which is healthy. However, if the special dividends are added to the mix, the payout ratio goes above 100% (for all the years the company had paid out a special dividend). Therefore, during those years the total dividend payment in terms of free cash flow is also above 100%.
Moving on to the balance sheet, Chow Tai Fook has been in a net debt position for the five years seen above, with the net debt level the highest in FY2019. The net gearing ratio for FY2019 was 33.2%, up from 15.6% in FY2018. Since the company has some debt on its balance sheet, it has to balance (pun not intended) between a few business priorities.
The Foolish takeaway
Chow Tai Fook has been rewarding shareholders well with increasing total dividends over the past three years, specifically. Since the company needs to balance paying out dividends to shareholders, re-investing into its own business, and paring down debt, the special dividend may not be sustainable, in my opinion.
As for the full-year dividend, as long as the company can increase its free cash flow considerably on a yearly basis, it should most likely sustain its full-year dividend. At a share price of HK$7.75 and excluding the FY2019 special dividend, Chow Tai Fook is selling at a still-respectable dividend yield of 4.5%.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Sudhan P doesn’t own shares in any companies mentioned.