3 reasons why Keppel Corp is unsuitable as a dividend stock

Blue-chip companies are named as such due to their size and long track record.

These factors make them popular among investors who are seeking the stability of a well-established company.

However, being businesses, even blue chips can fall on tough times if they do not play their cards right.

And when it comes to searching for suitable dividend-paying stocks , the ability to successfully navigate crises is an important attribute to look out for.

The Covid-19 pandemic has thrown a huge wrench into the growth plans of many blue-chip companies.

Keppel Corporation Limited  is one of them.

The conglomerate with diverse operations in offshore and marine, property, infrastructure and investments recently released its first-half fiscal 2020 earnings (1H 2020).

Unfortunately, it was a downbeat set of earnings, with revenue dipping slightly from $3.3 billion to $3.2 billion.

Keppel Corporation also took a hefty $930 million impairment charge, resulting in a sizable loss of $537 million for the quarter.

Although the oil rig giant has been highly regarded as a blue-chip company for many years, here are three reasons why I feel it falls short of qualifying as a suitable dividend stock.

1. Cyclical nature of offshore and marine

Keppel’s offshore and marine division is notoriously cyclical.

The division’s fortunes track the status of the oil and gas industry and are closely tied to the price of crude oil.

Offshore and marine makes up around a quarter of Keppel Corporation’s total revenue for 1H 2020 but contributed to the bulk of the losses.

The main reason for this was impairments of $930 million related to Keppel O&M’s stranded assets, receivables, inventories and share of impairment provisions from Floatel (an associate company).

These adjustments arose due to a second oil price crash that occurred earlier this year.

Oil prices dipped to as low as US$18 (S$25)/barrel and even briefly turned negative as demand fell off a cliff.

As it stands, it could take many more years before Keppel’s offshore and marine division can recover from these challenges, if at all.

The cyclical nature of the oil and gas industry is predicated on the price of a commodity and subject to geopolitical and economic forces that are beyond the group’s control.

With this inherent unpredictability, it’s also tough to be assured of stable cash flows and, by extension, dividends as well.

2. Patchy track record of dividend payments

A hallmark of a good dividend stock is the consistency of dividend payments.

Unfortunately, Keppel Corporation’s dividend history has been patchy as the conglomerate was badly impacted by the oil and gas bust back in 2014.

That crash saw the price of oil plummet from a high of U$105/barrel to a low of US$30/barrel in early 2016.

As business conditions deteriorated, so did its dividends.

The group’s dividend fell from $0.34 in the fiscal year 2015 (FY 2015) to just $0.20 in FY 2016 after the oil crash.

While dividends rose again to $0.22 in FY2017 and subsequently, $0.30 (including a special dividend of $0.05) in FY 2018, in FY2019, the annual dividend tumbled once again to $0.20.

This volatility in dividend payments does not inspire confidence in the group’s ability to pay out a steady and consistent dividend.

For 1H 2020, the interim dividend declared fell from S$0.08 to S$0.03 due to the aforementioned losses.

3. High debt levels, negative FCF

The two positive attributes that we look for in dividend companies are: a balance sheet that has little debt, and consistent free cash flow generation.

Sadly, Keppel Corporation does not satisfy either criterion.

The company’s balance sheet as of June 30, 2020 contains $5.4 billion of short-term debt and $7.3 billion of long-term debt, for a total of $12.7 billion in gross debt.

Cash balance stood at just $2.4 billion, for a net debt position of $10.3 billion.

Note that finance charges for the group amounted to $105 million in 1H 2020.

This was around a quarter of the core net profit of the group of S$393 million had it excluded the impairment charges.

For the half-year ended June 30, 2019 and 2020, the group generated negative operating cash flow.

4. Get smart: Stormy skies ahead

The troubles will not ease so soon for Keppel Corporation.

As the pandemic rages on and continues to depress oil prices, the group is trying to diversify its revenue across its other divisions.

Its business will continue to be negatively impacted and the group may reduce its final dividend as well.

Investors need to brace for lower dividends amid stormy skies.

This article was first published in The Smart Investor. Disclaimer: Royston Yang does not own shares in any of the companies mentioned.