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Should you be tempted by these high-yield dividend shares?

Image: Debenhams. Fair use.

Successful dividend investing involves more than just picking high-yield stocks. This is because struggling companies often carry temporarily high dividend yields, making it difficult to distinguish between good and bad companies.

With this in mind, I’m taking a look at the dividend sustainability of these two high-yield stocks.

Retail spending squeezed

Debenhams (LSE: DEB) dividend outlook is uncertain as trading conditions seem likely to become ever more tough. Yesterday’s results showed a 6.4% decline in pre-tax profits in the first-half of its 2016/17 financial year, as the rise in online shopping, coupled with rising inflation has left little cash left over for spending on the high street.

With profits getting squeezed, I reckon payouts could come under significant pressure from next year. Retail activity is already on the back foot, and the department store chain faces a huge challenge to remain relevant as consumer spending patterns, competition and technology are changing.

The retailer says its new Debenhams Redesigned strategy should help revitalise sales and drive efficiency by simplifying the business. It plans to close up to 10 of its department stores and 11 warehouses, revamp its remaining stores and improve its online and mobile shopping experience to make itself a destination for ‘Social Shopping’. This seems a step in the right direction. However, the question remains: will a turnaround in earnings come before a dividend cut becomes necessary?

City analysts expect earnings at the retailer to fall 14% this year and 9% next year, which still leaves the stock with reasonable dividend cover of around two times in 2017 and 1.8 times in 2018. However, when we factor-in the £216.9m in net debt on its balance sheet and plans to raise capital spending to £150m a year, there doesn’t seem to be a whole lot of flexibility to sustain dividends at current levels.

With an uncertain outlook ahead, I’m staying away from Debenhams’ 6.7% dividend yield.

Recovering confidence

Another high-yield dividend stock that’s been grabbing headlines recently is FTSE 250-listed asset manger Ashmore Group (LSE: ASHM). The emerging market debt specialist reported net inflows for the first time since 2014 as investors started to re-establish confidence in emerging markets.

Ashmore reported assets under management increased by 7% in the latest quarter to $55.9bn, following net inflows of $1.4bn in the first three months and strong investment returns since the start of the year. And with assets under management being regarded as an important indicator of future profits in the business, Ashmore’s earnings outlook seems to be improving.

City analysts expect Ashmore will see adjusted earnings growing 23% in this year, which gives it a forward dividend cover of 1.34 times. This would be an improvement on 1.15 times last year, but it’s still significantly below a level considered to be safe.

However, valuations seem attractive, with shares in the company trading at 15.8 times forward earnings this year, modestly below the sector average of 16.7 times. And with the stock up 23% year-to-date, Ashmore currently yields 4.7%, which is also noticeably better than the sector average dividend yield of 3.8%.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.