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Are these 6% yielders just investor traps?

Image: Admiral plc. Fair Use.

At first glance Debenhams (LSE: DEB) may appear to be a splendid pick for those seeking above-average returns in the near-term and beyond.

After years of keeping the dividend locked at 3.4p per share, the department store chain lifted the payout to 3.425p for the period to September 2016. Sure, this increase may not be much to write home about in itself, but it certainly signals Debenhams’ desire to provide its shareholders with plentiful rewards.

And the City expects this uptrend to continue. Again, a fractional year-on-year increase may only be expected for the current fiscal period — to 3.43p per share — but this figure still yields a fantastic 6.2%. By comparison the FTSE 100 forward average stands at a much more modest 3.5%.

But I believe Debenhams may find it difficult to meet these projections, even if dividend coverage meets the widely-regarded safety watermark of 2 times.

While like-for-like sales may have ticked higher in the year to September, a 0.7% advance is hardly a convincing figure to signal further revenue growth. Instead, the spectre of runaway inflation in the months ahead threatens to put high street spending under significant pressure, and with it Debenhams’ prospective profits .

Just this week the National Institute for Economic and Social Research (NIESR) predicted that inflation will hit 4% during the second of 2017. Consumer price inflation surged to 1% in September from 0.6% the prior month.

On top of this, Debenhams’ pension problems could also put paid to the likelihood of bountiful dividends looking ahead. The firm’s net deficit of £4.1m as of the end of August beat Morgan  Stanley’s £200m estimate by some margin. But a growing pension deficit is something to watch out for — indeed, Debenhams recorded a £26.2m net surplus just a year earlier.

I believe these factors make Debenhams a risk too far for those seeking chunky payouts.

Driving down?

Like Debenhams, motor insurance mammoth Admiral (LSE: ADM) also carries dividend forecasts that trash those of London’s blue-chip elite.

For 2016 the company is expected to pay a full-year dividend of 121.2p per share, creating a stunning 6.4% yield. And this figure nudges to 6.5% for next year thanks to a predicted 124.6p dividend.

While I believe Admiral’s robust position in the UK car market makes it a strong contender for reliable earnings growth — the number of customers in its home market leapt 11% during January-June, to 3.52m — questions abound over the strength of Admiral’s capital strength, and with it the prospect of bumper dividends this year and next.

As the boffins at UBS point out, Admiral plans to return between £100m–£150m of additional surplus capital over the next 2–3 years, down from the firm’s original target of £200m–£150m made back in March. The broker notes that “this is … because the Solvency 2 ratio has proven volatile in the wake of [the] UK Leave vote.”

Further volatility cannot be ruled out, of course, a situation that casts a pall over Admiral’s ability to pay market-mashing dividends. Consequently I believe investors in the insurance giant should be prepared for disappointment.

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