Does Tesco's dividend pass the test?
In the dividend report card series, we analyse financial metrics to begin answering the following questions about a company's dividend:
1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?
For a full explanation of each category, click here for a tutorial.
Today's pupil is Tesco (LSE: TSCO), which has a 3.7% expected yield.
Dividend history
| Metric | 5-Year
Annualised
Growth Rate |
|---|
| Dividend per share | 11.4% |
| Diluted earnings per share | 11.0% |
Source: Capital IQ, as of 30 July 2010
Tesco's dividend policy is to grow dividends broadly in line with diluted earnings per share growth. As you can see, it's achieved this goal over the past five years. In this category, then, Tesco scores a 5 out of possible 5.
Sustainability
| Metric | Trailing
12 Months | Final
Grade
Weighting | Report Card
Score
(out of 5) |
|---|
| Interest cover | 5.7 times | 10% | 4 |
| EPS payout ratio | 41.6% | 10% | 5 |
| FCFE payout ratio | 48.9% | 30% | 5 |
Source: Capital IQ, as of 30 July 2010.
Tesco has a strong balance sheet fortified with real estate holdings that the company can use to generate cash when times get tough. It also produces more than enough profit to cover its interest payments to its creditors, but this figure has been falling in recent years as Tesco has taken on more debt.
Investors would be wise to keep their eye on the interest cover ratio in the coming quarters. On a profit and free cash flow basis, Tesco's dividend is also well covered, so the current dividend appears quite sustainable.
Growth
| Metric | Trailing
12 Months | Final
Grade
Weighting | Report Card
Score
(out of 5) |
|---|
| EPS payout ratio | 41.6% | 10% | 4 |
| FCFE payout ratio | 48.9% | 20% | 4 |
| Sustainable growth rate | 9.9% | 10% | 4 |
Dividend growth has been one of the most attractive reasons to own Tesco shares -- since 2000 it's increased at a 12.5% annualized clip. I'm not sure it'll be able to repeat that performance in the next decade, but a high single-digit rate certainly isn't out of the question. And that's still quite good.
Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against its direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.
Source: Company REFS
Tesco's 3.7% expected yield is low relative to its competitors, but it also has the strongest earnings growth potential of the bunch due to its expanding international operations. These competitors generate nearly all of their sales in the UK whilst Tesco brings in 33% of sales from overseas -- and that slice of the pie is growing each year.
Pencils down!
With all the numbers in, here's how Tesco's dividend scored:
| Weighting | Category | Final Grade |
|---|
| 10% | History | 5 |
| | Sustainability | |
| 10% | Interest Coverage | 4 |
| 10% | EPS Payout Ratio | 5 |
| 30% | FCFE Payout Ratio | 5 |
| | Growth | |
| 10% | EPS Payout Ratio | 4 |
| 20% | FCFE Payout Ratio | 4 |
| 10% | Sustainable growth | 4 |
| 100% | Total Score
(out of 5) | 4.5 |
| | Final Grade | A- |
Frankly, this wasn't much of a surprise. Tesco has just about everything a dividend minded investor can want -- plenty of free cash flow and earnings cover, a good balance sheet, and a strong track record of raising dividend payouts.
Today's yield of 3.7% is above the FTSE 100 average, making Tesco an intriguing dividend share for investors looking for a consumer stock to add to their portfolio.
Previous dividend report cards:
> Fool analyst Todd Wenning does not own shares of any company mentioned. You can follow him on Twitter.
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