John D. Rockefeller — founder of the world’s first oil major, Standard Oil Company — once said “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in”. And the same goes for most investors.
Unfortunately, sitting back and letting the dividends roll in is the easy part of investing. Finding stocks that offer an attractive dividend yield that’s both sustainable and has room for growth is the tricky part.
Rio Tinto (LSE: RIO), Standard Chartered (LSE: STAN) and Centrica (LSE: CNA) all support attractive dividend yields. But how sustainable are the payouts?
Cutting corners
As the price of iron ore has slumped by as much as two-thirds over the past twelve months, Rio has been forced to drastically change its business plan.
The company currently supports a dividend yield of 4.9%, and City analysts believe that Rio’s management will hike the payout by 5% this year. However, as Rio’s dividend is set to hit 5.2% this year, the dividend cover is set to fall.
Analysts believe that Rio’s dividend payout will only be covered 1.2 times by earnings per share this year. That said, management has taken drastic action to ensure that the dividend remains safe for the time being.
Capital spending has been slashed its 2012 high of more than $16bn, to $8.2bn for 2014. Capex is expected to fall further to $7bn this year. Operational cost savings are expected to generate another $750m while lower interest payments on debt will free up more cash.
Thanks to management’s swift actions to turn the business around, Rio’s dividend looks safe for the time being.
Script safety
Standard has come under pressure from several major shareholders to cut its dividend payout to save cash and strengthen its balance sheet.
Management has rebuffed these calls for the time being and, to an extent, the company has a degree of flexibility with how it makes the payout.
There have been calls for the bank to issue its annual dividend as a script dividend — in shares rather than the traditional cash payout.
Standard already holds the crown as one of the most generous dividend payers among Britain’s listed companies, and management is unlikely to let this accolade disappear overnight.
The bank’s historic dividend yield currently stands at 5.3% and the payout is covered 1.8 times by earnings per share.
City analysts believe that Standard will cut its payout this year, with the yield projected to fall to 4.7%, although these are just forecasts. As Standard’s dividend payout is covered twice by earnings per share, the bank has plenty of room for manoeuvre.
Can’t be trusted
Centrica has already cut its dividend payout once in the past 12months, and I wouldn’t rule out another cut in the near future.
The most concerning thing about Centrica’s current position is the group’s rising level of debt and falling earnings, a worrying combination.
Centrica’s debt-to-equity ratio has jumped from 1.1 at the end of fiscal 2013, to 2.3 at the end of fiscal 2014. Over the same period, cash generated from operations has fallen by more than 50%. Centrica’s pre-tax profit fell from £1.7bn as reported for full-year 2013 to £1.4bn for full-year 2014.
Now, it is common for utilities to have high levels of debt. Nevertheless, a debt-to-equity ratio of 2.3 is concerning. Centrica’s peer SSE’s net-debt-to-equity ratio stands at around 1.3.
Centrica is set to support a dividend yield of 4.3% this year. The payout will be covered roughly one-and-a-half times by earnings per share.
