StarTek's Bad Voyage

Some dividends are dangerous. They'll suck you in with an enticing yield and then bury your portfolio with poor results. Sound unbelievable? Well, Fool, meet StarTek (NYSE: SRT  ) and its meaty 7.30% yield. This outsourcing firm based near my home in suburban Denver reported results for the fourth quarter and full year on Tuesday. And I'm still not impressed.

You can get all the relevant numbers here and here. Let's highlight two of the most important. First, sales were flat for the quarter and down more than 2% for the year. It was worse on the bottom line. There, StarTek reported roughly flat year-over-year results for the quarter and a breathtaking 38% decline from 2004 to 2005. Net out discontinued operations, and EPS for the quarter was up a cent and the decline for the year was something along the order of 33%.

It gets worse. In December, I criticized StarTek because it was paying out more in dividends than it was collecting in owner earnings (OE). To me, that signaled an unsustainable dividend. The full-year report does nothing to assuage my fear. Let me explain. My calculations peg 2005 OE at $10.4 million. Not bad, right? Right. Until, that is, you read that StarTek paid out $21.9 million in dividends. That's a payout ratio -- dividends paid divided by owner earnings -- of 210%.

Some may criticize my math because free cash flow (FCF) -- net cash from operations minus capital spending -- was up more than 700%, to better than $30 million. "That's more than enough to cover the dividend!" they'd say. Sure, but there's a problem: FCF benefited from more than $19 million in lower receivables and tax benefits. That would be fine if such working capital changes were routine. But they're not. Instead, the latest 10-K shows (check page 36) that StarTek's free cash flow was hit by taxes payable and/or increasing receivables in each of the previous three fiscal years. You'll have to forgive me, then, if I view 2005's prodigious FCF as an anomaly. OE isn't so easily manipulated, and I view it as the better metric here.

Bottom line: Dangerous dividends don't go away overnight. But StarTek's is looking a bit ominous to me.

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Fool contributorTim Beyersdidn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.


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