I’m looking at some of your favourite FTSE 100 companies and examining how each will deliver their dividends.
Today, I’m putting supermarket titan Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) under the microscope.
For the three years to 2006, Tesco’s dividend policy was to raise the dividend at a lower pace than earnings in order to increase dividend cover. However, the company announced a new policy within its annual results for 2006.
Having “built dividend cover to comfortable levels” — the dividend was covered 2.3 times by 2006 earnings — the board said: “We … intend to grow future dividends broadly in line with underlying earnings per share [EPS].”
The policy delivered good dividend growth for shareholders up to and including 2011: 11.7% (2007), 13.1% (2008), 9.7% (2009), 9.1% (2010), and 10.8% (2011).
The dividend growth reflected the strong growth in underlying EPS. Significantly, though, the underlying earnings measure was “inclusive of net property profit”. Tesco was rapidly expanding its estate in the so-called ‘race for space’ during the period. And a successful sale-and-leaseback programme was providing an extra boost to earnings and dividends: in fact, over 10% of group operating profit was coming from property.
Following terrible trading for Christmas 2011 and a profit warning, Tesco delivered 2.1% growth in both underlying EPS and dividend for the year ended February 2012. The company recognised there were serious problems within its core UK business, and announced a £1bn investment programme to try to get things back on track.
For the latest year — ended February 2013 — Tesco reported a 14% fall in underlying EPS to 35.97p and held the dividend at the previous year’s 14.76p. Despite the disconnect between EPS and dividend, the dividend was still covered 2.4 times by earnings — comfortably meeting the board’s “target cover of more than 2 times.”
New underlying EPS
There was no change to the policy of aiming to grow the dividend broadly in line with underlying EPS, but there was a significant change in how Tesco would calculate underlying EPS in future. Having abandoned the property race for space, the board said:
“We believe that it is appropriate to accelerate the scaling back of the sale and leaseback programme, such that it is unlikely to make a material contribution after the next few years.
“Our reported underlying profit measure includes these property profits and therefore its growth over the next few years will be held back by this accelerated reduction. We will therefore adjust for this impact when using underlying EPS as the basis for our dividend policy”.
In the future, then, the extra boost shareholders had long been getting to their dividends from property profits will disappear. It would require Tesco to grow trading profit faster than ever before to deliver the kind of dividend growth seen during the 2007-11 period.
Given the double-digit fall in trading profit last year and little sign of the trading environment improving in the immediate future, it looks a tall order for Tesco to deliver any meaningful growth in the dividend for the time being, far less the super-growth seen in the past.
However, there is some scope for the board to increase the dividend by reducing dividend cover, while still maintaining the cover above the two times target. According to consensus forecasts on Tesco’s website, this is what analysts are expecting the company to do, as the table below shows.
|2012/13 (actual)||2013/14 (forecast)||2014/15 (forecast)||2015/16 (forecast)|
Given the curtailment of property profits, the levels of dividend growth shown in the table wouldn’t be a bad outcome at all for shareholders — though the growth is predicated on Tesco making a steady recovery after the current year.
A number of notable investors have backed Britain’s biggest retailer to return to form. In particular, legendary US investor Warren Buffett has made a big bet on Tesco. The multi-billionaire owns 5% of the company’s shares.
> G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco.