The trading update last month from Pearson (LSE: PSON) provided its shareholders with a pre-Halloween fright. The textbook writer advised that total sales had declined 7% during the first nine months of 2016, including a catastrophic 9% decline in North America, Pearson’s largest market.
As well as having to endure “declines in assessment revenues in the US and UK,” the publishing giant also saw “declines in North American Higher Education courseware due to a further inventory correction by retailers in July and August.”
Despite these issues, the City expects Pearson to keep the full-year dividend locked around 52p per share through to the close of 2017, putting paid to its progressive payout policy but still creating a market-busting 6.9%.
Many income hunters will be encouraged by these forecasts, though I reckon shrewd stock pickers should steer clear. Pearson carries meagre dividend coverage of 1.1 times and 1.2 times for 2016 and 2017 respectively, some way below the widely-regarded ‘security’ watermark of two times.
And Pearson has seen debt levels explode in recent months. Net debt surged from £654m at the start of 2016 to £1.37bn as of September, the uptick reflecting the payment of dividends, currency movements, restructuring costs and contributions to the Pearson pension fund.
With Pearson battling a worsening balance sheet and massive structural changes to its key markets, I reckon the firm’s record of offering chunky dividends may about to be consigned to history.
Another dicey dividend pick
Fossil fuels colossus BP (LSE: BP) could also see its prestigious dividend scheme put to the sword should crude values fail to meaningfully recover.
Like Pearson, the number crunchers expect hulking debt levels and an uncertain revenues outlook to prompt BP to keep the dividend locked for the foreseeable future. Still, forecast dividends of 40 US cents per share through to the end of 2017 yield a very tempting 6.7%.
But BP’s $32.4bn net debt mountain (as of September), as well as expectations of earnings per share of just 18 cents this year and 42 cents in 2017, should raise serious concerns over these estimates being met. The crude colossus is clearly running out of firepower to meet such payout projections.
The company remains on an extensive restructuring programme to hive off non-core assets and cut costs, and just yesterday cut its capital expenditure targets yet again. BP now expects to spend $16bn this year, down from an original projection of $17bn-$19bn. And capex is expected to clock in at $15bn-$17bn in 2017.
Such measures underline BP’s desperate need to conserve cash as fears over the oil market’s chronic supply imbalance persist. Indeed, with OPEC and Russian production rattling along at record levels, and US drillers plugging their hardware back into the earth with increasing gusto, a much-needed revenues — and subsequent earnings — turnaround may be some way off.
I believe the risks far outweigh the potential rewards at BP.
