Will the Persimmon dividend grow or shrink?

Christopher Ruane explains why he’s upbeat about the long-term outlook for the Persimmon dividend, even after a massive cut last year.

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One of the attractions of owning shares in housebuilder Persimmon (LSE: PSN) in recent years has been the juicy payout. However, the total Persimmon dividend for last year came in at just 60p per share, barely a quarter of what had been paid the prior year.

That was the result of the company adopting a revised dividend policy amid deteriorating market conditions for housebuilders.

But what might lie ahead – a further cut, or the potential for a rise?

What drives the dividend?

I think a couple of points are important when trying to understand the Persimmon dividend.

One is the company’s profits. In order to keep paying a dividend, a company usually needs to generate earnings. With weakening demand in areas of the housing market and inflation putting pressure on profit margins, the outlook for Persimmon profits in coming years looks less bright than it did in recent history.

The company said today that, if current momentum holds, it expects to sell 8,000-9 ,000 homes this year. In each of the past two years, the number was close to 11,000.

So this year’s sales volumes are likely to fall sharply even if market conditions do not deteriorate further, which is itself a clear risk. Lower sales volumes will likely lead to smaller profits. Pre-tax profits last year already fell by 24% (albeit that was largely due to setting aside money to deal with legacy safety issues like cladding), while free cash flows halved.

But the second part of understanding a dividend is the payout ratio. For years, Persimmon paid out almost all of its earnings as dividends. Slashing the dividend last year meant that basic earnings still covered the dividend almost three times over, despite lower profits.

That coverage gives me confidence that the dividend is unlikely to shrink further in the next few years unless business performance deteriorates significantly. The shares currently yield 4.6%.

Long-term outlook

But could the dividend grow?

I think so, which is why I bought Persimmon shares this year and plan to hold them.

In the short term, I do not expect dramatic growth. Clearly the outlook for the housing market remains uncertain and I think company management will be cautious when setting the dividend.

But as a long-term investor, I am looking further ahead. In the coming decade, I think the country’s housing shortage can help sustain buoyant demand even if economic uncertainty has a short-term negative impact on sales levels.

As Persimmon noted in today’s trading statement: “The longer-term demand fundamentals for new homes remain robust.”

If selling prices stay strong, the firm could produce substantial profits in coming years even on smaller sales volumes.

At some point, I hope volumes will start to grow again. With its model of vertically integrated component manufacturing and high historical profit margins, I expect the company to do well in the future. I think that could form the basis for growth in the dividend.

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.

C Ruane has positions in Persimmon Plc. The Motley Fool UK has no position in any of the shares mentioned. 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.

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