Something To Consider Before Buying China Electronics Huada Technology Company Limited (HKG:85) For The 2.7% Dividend

Simply Wall St

Today we'll take a closer look at China Electronics Huada Technology Company Limited (HKG:85) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

Investors might not know much about China Electronics Huada Technology's dividend prospects, even though it has been paying dividends for the last six years and offers a 2.7% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on China Electronics Huada Technology!

SEHK:85 Historical Dividend Yield, February 28th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, China Electronics Huada Technology paid out 38% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, China Electronics Huada Technology paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is China Electronics Huada Technology's Balance Sheet Risky?

As China Electronics Huada Technology has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With a net debt to EBITDA ratio of 15.25 times, China Electronics Huada Technology is very highly levered. While this debt might be serviceable, we would still say it carries substantial risk for the investor who hopes to live on the dividend.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. China Electronics Huada Technology has interest cover of less than 1 - which suggests its earnings are not high enough to cover even the interest payments on its debt. This is potentially quite serious, and we would likely avoid the stock if it were not resolved quickly. Low interest cover and high debt can create problems right when the investor least needs them, and we're reluctant to rely on the dividend of companies with these traits.

Consider getting our latest analysis on China Electronics Huada Technology's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. China Electronics Huada Technology has been paying a dividend for the past six years. It's good to see that China Electronics Huada Technology has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past six-year period, the first annual payment was HK$0.03 in 2014, compared to HK$0.02 last year. The dividend has shrunk at around 6.5% a year during that period. China Electronics Huada Technology's dividend has been cut sharply at least once, so it hasn't fallen by 6.5% every year, but this is a decent approximation of the long term change.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. China Electronics Huada Technology's EPS have fallen by approximately 21% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and China Electronics Huada Technology's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that China Electronics Huada Technology's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we like China Electronics Huada Technology's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. In summary, China Electronics Huada Technology has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Now, if you want to look closer, it would be worth checking out our free research on China Electronics Huada Technology management tenure, salary, and performance.

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.