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Are dividends doomed at these FTSE 100 favourites?

Image: HSBC. Fair use.

The fall in the value of sterling since the EU referendum result has turned the FTSE 100 into a two-track index. Demand has been lukewarm for many UK-focused businesses, which are facing rising import costs and likely lower economic growth (possibly even a recession). But there’s been a strong appetite for companies with international earnings, which are benefitting from weaker sterling.

However, there are companies on both sides of the fence whose dividends could be under threat. Do shareholders of UK supermarket operator J Sainsbury (LSE: SBRY) and global banking giant HSBC (LSE: HSBA) give equal cause for concern?

Further dividend pain

Competition in the supermarket sector remains fierce as the mid-market giants battle to adjust to the market share grab by the likes of Aldi and Lidl at the discount end and Waitrose and Marks & Spencer at the higher end.

Sainsbury’s paid a dividend of 17.3p a share for its financial year ended March 2014, but in the face of the increasingly challenging trading environment it moved from a ‘progressive’ dividend policy to an ‘affordable’ one. The board said it would pay dividends at a rate of 50% of earnings (i.e. maintain dividend cover of two times).

Earnings have since declined annually, and as a result the dividend was reduced to 13.2p for fiscal 2015, followed by 12.1p for fiscal 2016. Analyst are forecasting a further fall in earnings — to 20.4p — for the year to March 2017, which implies a third consecutive dividend cut, to 10.2p, giving a yield of 3.9% at 259p.

The good news is that the yield isn’t bad compared with the FTSE 100 average. The less good news is that earnings (and thus the dividend) are forecast to be flat for fiscal 2018, which would mean another cut to the payout in real terms, because inflation is widely expected to rise quite significantly in the coming period.

This is an uninspiring prospect, and I believe that there are stronger dividend choices in the FTSE 100.

Divided on the dividend

HSBC’s earnings have also been in decline of late, but, in contrast to Sainsbury’s, the dividend has continued to tick up. Last year’s 51 cents payout was covered 1.27 times by earnings of 65 cents.

The analyst consensus is for earnings to fall to 45 cents this year, but for HSBC to maintain the dividend at 51 cents. However, the City is divided on payout prospects for 2017. The most optimistic analysts are only expecting a maintained payout at 51 cents, while the most pessimistic are forecasting a 50% cut.

At the current dollar/sterling exchange rate 51 cents equates to about 40.8p, giving a yield of 6.8% at a share price of 600p. A 25% cut to the dividend would reduce the yield to 5.1%, while the most bearish forecast of a halving of the payout would give a 3.4% yield. And of course, there’s the additional uncertainty of exchange rate movements, with the yields moving higher if sterling weakened further during the period or lower if it strengthened.

I believe HSBC remains an attractive investment for long-term global growth, but it wouldn’t be a big surprise to see the dividend rebased in 2017.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.