What Does Dairy Farm International Holdings Ltd’s Free Cash Flow Tell Investors About Its Dividend?
Dairy Farm International Holdings Ltd (SGX: D01) is a Pan-Asian bricks-and-mortar retail company that runs a wide variety of retail formats, including supermarkets, hypermarkets, convenience stores, pharmacies, home furnishing stores, and restaurants. It currently has over 6,500 outlets.
In Singapore, retail stores that are under Dairy Farm include Guardian, Cold Storage, Giant, and 7-Eleven.
The company has a long-term track record of paying an annual dividend that stretches back to at least a decade. But that is then and this is now. Can Dairy Farm sustain or grow its dividend? The question gains importance when we consider that the bricks-and-mortar retail industry has been facing a challenging time these past few years due to the growth of online retail.
Unfortunately, there is no easy answer to the question. But, there are still some things about Dairy Farm’s business we can look at for clues. Here are three of them, keeping in mind that they are not the only important aspects: (1) the company’s profit history, (2) a comparison of the company’s free cash flow and dividend, and (3) the company’s balance sheet strength.
Free cash flow
For a company to be able to sustain its dividend payments, it must be able to generate cash to pay its bills and to maintain its businesses in their current state. The left over cash can then be used to pay dividends.
In the financial community, that left-over cash is known as free cash flow and it is found by subtracting a company’s capital expenditure from its cash flow from operations. It is not sustainable over the long-term for a company to pay out more in dividends as compared to the free cash flow it generates.
Here’s a table showing how Dairy Farm’s free cash flow and dividends paid have changed from 2012 to 2016:
Source: Dairy Farm’s annual reports
We can see that Dairy Farm’s free cash flow had reasonably covered its dividend payments from 2012 to 2013. From 2014 onwards though, the retailer’s free cash flow started deteriorating significantly; in this period, the total deficit between Dairy Farm’s free cash flow and dividends paid was nearly US$1.2 billion. The shortfall was funded by debt and the company’s cash on the balance sheet.
This act of Dairy Farm paying more in dividends than the free cash flow it brings in is not sustainable over the long-run. Investors should watch for signs of improvement in the company’s free cash flow.
A Foolish conclusion
Earlier in this article, I had shared three things about a company’s business that investors could look at for clues about a sustainable dividend. The second is something we have just studied for Dairy Farm. As for the first and third, it turns out that:
1) Dairy Farm has been solidly profitable from 2012 to 2016, but the company has struggled to grow its bottom-line.
2) The company has a reasonably healthy balance sheet.
In summary, Dairy Farm is a pan-Asia retailer that has been unable to grow its profit by much and that has seen its free cash flow deteriorate in recent years. But, given its reasonably strong balance sheet, Dairy Farm should still be able to sustain its current dividend over the next two to three years. Over the longer term, the ability of Dairy Farm to sustain its dividends will depend on how well it can cope with the challenges from online retail.