Is Four Seas Mercantile Holdings Limited (HKG:374) A Smart Pick For Income Investors?

Is Four Seas Mercantile Holdings Limited (HKG:374) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With Four Seas Mercantile Holdings yielding 3.4% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding Four Seas Mercantile Holdings for its dividend, and we'll focus on the most important aspects below.

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Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 141% of Four Seas Mercantile Holdings's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Four Seas Mercantile Holdings's cash payout ratio in the last year was 44%, which suggests dividends were well covered by cash generated by the business. It's good to see that while Four Seas Mercantile Holdings's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is Four Seas Mercantile Holdings's Balance Sheet Risky?

As Four Seas Mercantile Holdings's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Four Seas Mercantile Holdings has net debt of 0.81 times its EBITDA, which we think is not too troublesome.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Four Seas Mercantile Holdings has EBIT of 5.98 times its interest expense, which we think is adequate.

Remember, you can always get a snapshot of Four Seas Mercantile Holdings's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Four Seas Mercantile Holdings's dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was HK$0.07 in 2010, compared to HK$0.095 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.1% a year over that time.

While the consistency in the dividend payments is impressive, we think the relatively slow rate of growth is unappealing.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Four Seas Mercantile Holdings's earnings per share have shrunk at 30% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Four Seas Mercantile Holdings's earnings per share, which support the dividend, have been anything but stable.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Four Seas Mercantile Holdings out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Case in point: We've spotted 4 warning signs for Four Seas Mercantile Holdings (of which 2 make us uncomfortable!) you should know about.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.