What Are Tesco plc’s Dividend Prospects Like Beyond 2014?

Today I am looking at British grocery giant Tesco‘s (LSE: TSCO) (NASDAQOTH: TSCDY.US) dividend outlook past 2014.

Weak sales cast pall over dividends

Tesco is not alone in suffering increasing pressure in the UK supermarket space, as the surging popularity of budget retailers and premium stores top-and-tail the sector and leave an increasingly small space for the mid-tier operators to scramble around in.

The bellwether of the UK food sector struggles to stay top of the tree,” broker CMC Markets notes. “Its market share continues to decline, eroded by the performance of budget retailers Aldi and Lidl, while the performance of Waitrose and J Sainsbury also helped to dent its market share.”

Indeed, Tesco once again confirmed its prolonged sales tailspin last week when it announced total sales excluding petrol declined by 1.2% in the six weeks to January 4, while on a like-for-like basis these fell 2.4% during the period.

City forecasters expect continued sales pressure to result in a 14% reduction in earnings for the 12 months ending February 2014, before the firm’s turnaround strategy delivers modest rebounds to the tune of 2% and 4% in 2015 and 2016 respectively.

Tesco elected to keep the full-year dividend on hold at 14.76p per share last year as earnings slipped 11%, and further heavy weakness for 2014 is expected to result in a similar move. But the expected medium-term recovery is expected to result in an 2.3% rise in the payout in 2015, to 15.1p, with an additional 2.7% increase pencilled in for 2016 to 15.5p.

The prospective payments for 2014 results in a bumper yield of 4.6%, with predicted hikes in over the medium term creating readouts of 4.7% and 4.8% for 2015 and 2016 correspondingly. This beats the average forward yield of 3.2% for the FTSE 100 hands down.

Still, investors should be aware that the supermarket faces increasing — and not decreasing — headwinds in the British grocery space which could blow these miserly earnings improvement forecasts off course and stymie future dividend growth.

Although dividend cover above the security benchmark of 2 times earnings — at 2.1 times — through to 2016 provides some degree of comfort, I do not consider this robust enough given that the company’s market share continues to nosedive. And with Tesco’s capital-intensive recovery strategy, which extensive store refurbishments and new convenience store unveilings, set to pressure the bottom line even further, dividend growth is in danger of heavy pressure.

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> Royston does not own shares in Tesco. The Motley Fool owns shares in Tesco.