Are dividend cuts inevitable at Talktalk Telecom Group plc, Vedanta Resources plc and Interserve plc?

Roland Head explains the risks threatening dividend payouts at TalkTalk Telecom Group plc (LON:TALK), Vedanta Resources plc (LON:VED) and Interserve plc (LON:IRV).

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

TalkTalk Telecom Group (LSE: TALK) announced a 15% dividend increase alongside its 2015/16 results on Thursday morning. This takes the total payout to 15.87p per share for last year. That’s equivalent to a yield of 5.9%.

The only problem is that this dividend looks increasingly unaffordable to me.

TalkTalk’s dividend payout cost the firm £135m last year. At the same time, net debt rose by £90m to £679m. I believe this increase would have been much bigger if TalkTalk hadn’t been able to raise £61m in a one-off sale of surplus shares from its Employee Share Ownership Trust.

These figures make it clear to me that a sizeable part of TalkTalk’s dividend is being funded with debt. This has been the case for several years, in my opinion. This is one reason why the company’s net debt is now a whopping 8.6 times last year’s adjusted post-tax profits.

Adjusted earnings per share are expected to rise by 58% to 14.6p in 2016/17. TalkTalk said on Thursday that it expects to free cash flow to cover the dividend this year. The firm has been investing in new services, so these gains may be possible.

However, even if TalkTalk does deliver on forecasts, the stock’s 2017 forecast P/E of 18 looks expensive to me. I think there’s better value elsewhere.

Can this mining giant beat the odds?

Indian mining giant Vedanta Resources (LSE: VED) has cut its dividend by 52% to 30 cents per share after unveiling a full-year loss of $1.8bn. The firm’s revenue fell by 17% to $10.7bn last year, while earnings before interest, tax, depreciation and amortisation fell by 38% to $2.3bn.

The reduced dividend still provides an attractive yield of 5.5%, although shareholders who bought at higher prices may be disappointed. There was some good news, however. Vedanta was able to reduce its net debt by $1.1bn to $7.3bn, thanks to free cash flow of $1.7bn.

The problem is that the firm’s debt commitments remain massive. Vedanta made interest payments of $1.2bn last year. That’s more than 10% of its revenue. While debt remains high, the shares are fundamentally risky. That’s why I’m not convinced the dividend is safe, even though this year’s dividend payout will cost the firm just $83m.

More trouble may lie ahead

Shares in construction and support services firm Interserve (LSE: IRV) fell by 23% in one day last week after the firm warned it would have to take a £70m cash impairment on a project in Glasgow.

Interserve didn’t provide any updated profit or dividend guidance in its statement. This seems to have left City analysts uncertain about whether to cut their forecasts. Consensus forecasts for earnings and dividends published by Reuters have so far remain unchanged. These estimates suggest that Interserve now trades on a 2016 forecast P/E of just 4.8 and offers a prospective dividend yield of 8%!

Given that Interserve has already warned net debt will rise by £35m as a result of the £70m charge, I believe a dividend cut is a significant risk. I’d be tempted to wait until the picture is a little clearer before considering an investment.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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

More on Investing Articles

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

1 Warren Buffett stock I’m buying now

Coca-Cola is the fourth-largest holding in Warren Buffett’s Berkshire Hathaway. I’ll explain why I’m following Buffett and buying more.

Read more »

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

I bought 4,403 Lloyds shares in June and 4,856 in September. Here’s what they’re worth now

Harvey Jones thought he was bagging a FTSE 100 bargain when he bought Lloyds shares on two occasions last year.…

Read more »

Young woman holding up three fingers
Investing Articles

I’m itching to buy these 3 hidden FTSE gems in a Stocks and Shares ISA

Harvey Jones is keen to add these three FTSE 100 companies to his Stocks and Shares ISA before April. Only…

Read more »

Close up of a group of friends enjoying a movie in the cinema
Investing Articles

How I’d try and turn just £1 a day into a fabulous £54,485 passive income for life

By investing small, regular sums in FTSE 100 shares I can potentially generate a huge passive income stream. It won't…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

I’d aim for a million buying under a dozen shares

Christopher Ruane explains why less could be more when it comes to building a share portfolio if he wants to…

Read more »

Investing Articles

Rolls-Royce shares are up over 1,000% since 2020! Am I too late to buy?

Rolls-Royce shares now cost over tenfold what they did in the firm's 2020 rights issue. Our writer thinks they may…

Read more »

Investing Articles

1 top UK growth stock for my tech portfolio in 2024

Up 30% in just one year, this growth stock looks positioned to continue on the path of substantial gains, according…

Read more »

Buffett at the BRK AGM
Investing Articles

I’d follow Warren Buffett to target effortless passive income

Warren Buffett knows a thing or two about building passive income streams. By learning from the Sage of Omaha, so…

Read more »