I’m always on the lookout for big FTSE 100 companies when they’re being offered in the market at an attractive valuation for dividend investors. A little higher yield at the time you buy can make a big difference to the growth of your income stream over the long term.
Right now, I reckon Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US) is looking a great buy for income.
Morrisons’ shares slumped 12% last Thursday, when the company released its final results for the year to 2 February. Management’s decision to take on the discounters Aldi and Lidl with £1bn of price cuts over three years hit the whole sector, because of market fears of Tesco, Sainsbury’s and Wal-Mart-owned Asda joining an escalating price war.
Morrisons’ “investment in pricing” meant the board slashed its underlying profits guidance for 2014/15 to a range of £325m to £375m. Given that the company’s annual dividend payout is currently running at just over £300m, it all sounds pretty scary for those investors who are in the share for income.
Dividend shock
Perhaps the most surprising thing in Morrisons’ results last week was the board’s declaration of a 9.16p final dividend, giving a total of 13p for the year, representing a rise of 10% on 2012/13. Analysts had expected the company to renege on its three-year commitment to 10% increases in what was the final year.
Furthermore, the board has said it anticipates raising this year’s dividend to at least 13.65p, with progressive and sustainable growth thereafter.
Given market expectations, there was no need for Morrisons to be so gung-ho with the dividend. Is the board being extraordinarily reckless, or can it deliver?
Cash is king
Free cash flow is the lifeblood of dividends, and Morrisons is targeting £2bn of it over the next three years: half from operating improvements, working capital and reduced capex, and half from property disposals. This isn’t difficult to achieve, and a modestly rising dividend over the period would be more than twice covered by free cash flow.
By that time, Morrisons should be seeing the benefits of its accelerating entry into the fast-growing online and convenience store channels and the introduction of a loyalty card.
A great opportunity right now
Morrisons’ shares are trading at 206p at the time of writing. The final 9.16p dividend alone represents a yield of 4.4% (the ex-dividend date is 7 May), and with the minimum 13.65p commitment for 2014/15 we’re looking at a whopping 18-month yield of over 11%.
The share price and yield suggest the market is discounting a dividend cut. Earnings will no doubt struggle for a while, but if management’s confidence in the three-year cash-flow strategy and longer-term prospects of its multi-channel offering is justified, Morrisons could prove to be one of the best income buys in the market today.
