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Forget the huge yields and dump these Footsie frighteners

Photo: Magnascan (pixabay). License: CC0 Public Domain.

The earnings outlook for Capita Group (LSE: CPI) has become significantly scarier in the wake of the UK’s Brexit referendum.

The outsourcing giant was forced to scale back its full-year profit forecasts in September as delayed investment decisions weighed on its business. Indeed, Capita said that underlying pre-tax profit would range between £535m and £555m “as a result of a slowdown in specific trading businesses, one-off costs incurred on the Transport for London congestion charging contract and continued delays in client decision making.”

And latest news from the support services sector has cast further concern over Capita’s sales prospects. Sector peer Mitie Group this week warned on profits for the second time since June’s vote, the company citing “uncertainties both before and after the EU referendum.” Sales at the company slipped 2.6% during April-September, to £1.09bn.

The fog surrounding the timing and terms of Britain’s European exit is likely to persist long into the future, making forecasts for the likes of Capita extremely risky business. Having said that, it’s not beyond the realms of possibility that further downgrades to profit estimates could be made.

Despite these pressures however, the City expects Capita to lift last year’s dividend of 31.7p per share to 32.1p this year and 32.7p in 2017. These figures yield an eye-popping 5.5% and 5.6%.

While dividend coverage stands above the safety benchmark of two times, I reckon Capita’s worsening sales outlook still puts these weighty projections in serious jeopardy, particularly as debt levels are rising — net debt jumped to £1.9bn as of June.

Are the lights going out?

A patchy earnings picture also puts Centrica’s (LSE: CNA) progressive payout policy on perilous ground, in my opinion.

Despite expectations of a third annual earnings dip in 2016, the number crunchers expect the British Gas operator to lift the dividend to 12.2p per share from 12p last year. And an even meatier hike, to 12.7p, is forecast for next year.

But quite why the City expects Centrica to raise the dividend following two years of cuts is quite beyond me, I’m afraid. That’s especially so as not only does the company boast meagre dividend coverage of 1.3 times for this year and next, but the energy giant is also toiling under a massive £3.8bn net debt pile.

And Centrica can’t be considered on the cusp of a stunning earnings turnaround either to bolster the board’s appetite to raise the dividend. Customers are flocking to smaller, promotion-led suppliers with increasing gusto. And the prospect of oil prices remaining subdued well into the future also threatens to keep profits at the firm’s Centrica Energy arm under huge pressure.

As a consequence, I reckon investors should give short shrift to Centrica’s giant yields of 6% and 6.3% for 2016 and 2017.

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