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How BAE Systems plc Will Deliver Its Dividend

I’m looking at some of your favourite FTSE 100 companies and examining how each will deliver their dividends. Today, I’m putting aerospace and defence group BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) under the microscope.

Dividend policy

BAE’s dividend policy has been couched in broadly the same terms for many years. In the company’s most recent annual results it was stated as:

“To pay dividends in line with its policy of a long-term sustainable cover of around two times underlying earnings”.

BAE came close to a merger with European group EADS during 2012, raising fears among BAE shareholders of a dividend cut. The merger didn’t go ahead, and there was a new shareholder-friendly addendum to BAE’s dividend policy when the company announced its annual results:

“To make accelerated returns of capital to shareholders when the balance sheet allows”.

BAE repeated both the dividend policy and the potential for accelerated returns of capital when its first-half results for 2013 were released earlier this month.

Dividend history

As the 10-year figures in the table below show, BAE’s dividend record has been good overall: average annual growth in the payout has been just shy of 8% through the period.

Year Dividend
per share
Dividend
growth
Dividend
cover
2012 19.5p 3.7% 2.0
2011 18.8p 7.4% 2.4
2010 17.5p 9.4% 2.3
2009 16.0p 10.3% 2.5
2008 14.5p 13.3% 2.6
2007 12.8p 13.3% 2.4
2006 11.3p 9.7% 2.1
2005 10.3p 8.4% 2.2
2004 9.5p 3.3% 1.9
2003 9.2p 0.0% 1.8

The table shows clearly how the board’s commitment to maintaining a dividend covered around two times by earnings has produced an ebb and flow in dividend growth.

We can deduce from the decision to hold the 2003 dividend at the 2002 level that the board was not prepared to see dividend cover fall below 1.8. In contrast, management has been prepared to let dividend cover rise a good way above the two-times level of the policy (reaching 2.6 for 2008). The now looks to have been a prudent decision, because after a few tough years for earnings, dividend cover has fallen back to 2.0.

Dividend prospects

BAE announced a skinny 2.6% increase in the interim dividend within its recent first-half results. But, comfortingly for shareholders, the company also said: “double-digit growth in underlying earnings per share is anticipated for 2013”.

Analyst forecasts currently look like this:

Year Dividend
per share
Dividend
growth
Dividend
cover
2013 20.2p 3.6% 2.1
2014 20.7p 2.5% 2.0

As you can see, modest dividend growth and cover maintained at around two times is forecast for this year and next. If we take cover over 1.8 as the level at which the board might consider only maintaining the dividend at the previous year’s level (as in 2003), earnings would have to disappoint quite significantly for shareholders to see 0% dividend growth — and very significantly for there to be an actual dividend cut. As such BAE’s forecast 4.6% yield at a share price of 440p looks reasonably secure.

BAE has attractions for income investors, but I have to tell you that the Motley Fool’s chief analyst believes there’s another blue-chip company — currently offering a prospective income of 5.7% — that right now ranks as the UK’s top income stock.

You can read our leading analyst’s in-depth review of the company in this exclusive free report.

The report comes with no obligation and can be in your inbox in seconds — simply click here.

G A Chester does not own any shares mentioned in this article.