Don’t bank on these 6% dividend yields to deliver a large retirement income

Royston Wild looks at two huge yielders that could disappoint dividend pickers in the near term, and quite possibly beyond.

| More on:

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.

Pendragon (LSE: PDG) has seen its share price fall around 20% over the past year as demand for new cars has steadily evaporated.

I would argue that the rate at which auto sales are slumping should have produced an even larger decline, and believe that a sharp shock lower could be just around the corner.

The Society of Motoring Manufacturers and Traders (SMMT) underlined the worrying state of the new car market on Thursday with news of a 3.5% drop in new vehicle sales in June. In the six months to last month, total volumes were down 6.3% from the corresponding period last year, at 1.31m units.

It’s no surprise that Pendragon is struggling in this situation. It endured a 13.3% drop in new vehicle revenues during January-March and gross profit from new cars careered 17.6% lower year-on-year. Therefore, underlying group pre-tax profit more than halved during Q1 to £15.1m, in spite of massive cost-cutting that resulted in savings of £3.9m.

In a spin

City analysts are expecting earnings to edge 3% higher in 2018 before the rate of improvement increases to 14% next year. Pendragon may be expecting sales to pick up during the latter half of the year, thanks to weak comparatives in the corresponding 2017 timespan. I am not convinced though, given the mounting pressure on Britons’ spending power that should keep hammering car sales. Thus, a low forward P/E ratio of 7.2 times has no appeal to me at least.

I am concerned by this, as well as the impact of Pendragon’s swelling debt pile on future dividends. Sure, the car retailer may not be hamstrung by debt, but the rate at which loans have risen should make any income investor sit up and take notice. This jumped £32.4m last year to stand at £124.1m as of December.

The anticipated dividend freeze through to the end of next year, at 1.55p per share, therefore may be considered a tad optimistic. And so investors should put little faith in the company’s bulky 6.4% yield.

Out of date?

The Restaurant Group (LSE: RTN) is another big-yielding share I reckon could fail to meet lofty dividend expectations.

City brokers are expecting the Frankie & Benny’s owner to succumb to sustained earnings woes and cut the dividend in 2018 (an extra 5% profits reverse is forecast for this year). The business has kept the payout level at 17.4p per share for the past three periods, but is expected to reduce it to 16.8p.

On the plus side, the yield stands at a mighty 6%. And glass-half-full investors will also point to Square Mile predictions of a 7% earnings recovery next year, and a subsequent dividend raise to 16.9p (yielding 6.1%) as reasons to be optimistic.

Latest trading details showed like-for-like sales ducked 4.3% during the 20 weeks to May 20, keeping the relentless run of disappointing releases coming. And with the environment becoming tougher amid constrained consumer spending power and intense competition, and cost inflation adding another problem, I believe a bigger dividend reduction could be in the offing.

What’s more, a forward P/E ratio of 13.1 times isn’t that compelling either when you consider that The Restaurant Group’s turnaround strategy is still failing to fire. And the risks  for the company’s retail park-based restaurants are growing as the e-commerce boom continues. There are many other big-yielding shares with better investment potential than this one, in my opinion. Speaking of which…

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Pendragon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Here’s how I’d target £496k in FTSE 100 shares and £19k of passive income in a Stocks & Shares ISA

I invest as much surplus cash as I can at the end of the month in my Stocks and Shares…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Is Rolls-Royce’s share price an irresistible bargain?

Is Rolls-Royce's share price the FTSE 100's greatest bargain today? Royston Wild explains why he would -- and wouldn't --…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Is the Vodafone share price a wonderful bargain or a horrible value trap?

As the Vodafone share price continues to fall, is it now a stock to buy with a view to a…

Read more »

Hand of a mature man opening a safety deposit box.
Investing Articles

I’d buy 95,239 shares of this banking stock to generate £200 of monthly passive income

Muhammad Cheema takes a look at how Lloyds shares, with a dividend yield of 5.9%, can generate a healthy monthly…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Can FY results give the Antofagasta share price a long-term boost?

The Antofagasta share price has had a good five years. Now the company says it's set to enter a new…

Read more »

Person holding magnifying glass over important document, reading the small print
Dividend Shares

Can I make sustainable passive income from share buybacks?

Jon Smith notes the rise in share buybacks from FTSE 100 companies, but flags up why they aren't great for…

Read more »

Front view of a mixed-race couple walking past a shop window and looking in.
Investing Articles

After the Currys share price rockets, here are more potential UK takeover targets!

The Currys share price has surged 39% higher in response to news of a takeover bid. Which UK stocks could…

Read more »

Investing Articles

Down 25%, where will the British American Tobacco share price go next?

The British American Tobacco share price has taken a hit. But this Fool isn't deterred. He think's now could be…

Read more »