Why these 5% yields could be under threat

Bilaal Mohamed explains why these two dividends are looking increasingly exposed to a cut.

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It’s certainly been a painful year for long-term shareholders of mobile telecoms firm Inmarsat (LSE: ISAT), with the company’s shares now trading 33% lower than a year ago, and close to three-year lows.

On the flipside, however, this could be an ideal opportunity for new investors to jump in and grab a stake in the global satellite communications provider at a heavily discounted price, with the added attraction of an inflated dividend yield.

Weaker government spending

The FTSE 250 telecoms firm has an excellent track record when it comes to dividends, increasing its shareholder payouts every year since it was first listed on the London Stock Exchange in 2005. But shares prices don’t normally plummet without good reason, and earlier this year Inmarsat reported a 17.3% drop in pre-tax profits for 2015 amid weaker global government spending, with revenues remaining broadly flat. The company also reported a 17% fall in underlying earnings, the biggest fall since the company’s IPO over a decade ago.

In its latest trading update earlier this month, the company said it was making solid progress in challenging markets, and revealed an $18.8m increase in group revenues for the third quarter of 2016, representing a 5.8% improvement on the same period last year. But pre-tax profits came in 13.3% lower at $53.9m, a fall of $8.3m year-on-year, due to higher depreciation and financing costs.

Cuts on the cards?

I think trading will continue to be challenging, with economic and budgetary pressures affecting its customers, and City analysts seem to agree. Consensus forecasts suggest that full-year profits will shrink by another 17% this year, leaving the shares looking a little expensive at 17 times earnings. But what about the dividend? The sharp fall in the share price this year has lifted the prospective yield to almost 6%, giving income investors something to think about.

Unfortunately this forecast dividend payout is barely covered by estimated earnings, and current projections indicate that 2017 will be no better. It’s very likely that Inmarsat will continue with its progressive dividend policy for the next couple of years, but unless earnings improve dramatically, future cuts may well be on the cards.

Tough chromium business

In contrast with Inmarsat, fellow mid-cap struggler Elementis (LSE: ELM) hasn’t seen its shares punished in the same way as the satellite telecoms firm this year. In fact after a bumpy ride, the share price has recovered back to where it was a year ago. In that respect I think the shares have done pretty well considering the company’s recent poor performance.

After five years of growth, the speciality chemicals business reported a 14.12% decrease in sales for 2015, together with an 18.39% reduction in operating profit, impacted by a significant downturn in oil and gas drilling activity and the effects of a stronger US dollar. I don’t think we’re going to see much improvement this year either, as management admitted in its recent update that although sales for speciality products had improved, the environment for its chromium business
remained challenging.

Market consensus estimates are suggesting a further 20% fall in earnings for the full year on lower sales revenues, and although the prospective yield looks attractive at 5.3%, payouts are only just covered by forecast earnings. Historically, Elementis has had ample dividend cover of around three times earnings. On that basis payouts over the next few years look to be on shaky ground.

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.

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

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