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How Strong Are Tesco PLC’s Dividends?

Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) has been in the wars of late — the price wars, that is, in an attempt to win back customers from its rivals. That’s led to falling like-for-like sales, as the deflationary effect of price cuts is being felt at the tills.

TescoIn its first-quarter update, released on 4 June, the UK’s biggest supermarket chain told us that like-for-like sales, excluding petrol, had dropped 3.7%. But things need to be kept in perspective — Tesco still sells around 30% of the groceries bought every week. And the firm’s store refurbishment programme is well under way, too, with a target of 650 new-look stores to aim at.

Dividends still good

Meanwhile, there’s good news on the dividend front.

The annual payout has been pegged at 14.76p per share for the past three years, but for the year to February 2014 that did provide a yield of 4.4%. That’s historically high for the supermarket sector, and it was more than twice covered by earnings per share (EPS). The company didn’t say much more than that about future plans, but what do the analysts think is going to happen?

Well, with EPS predicted to fall by a further 16% in the current year, there’s a consensus forecast of 14p per share for February 2015 as a few of theme expect the payment to be cut. But a few are sticking with a repeat of last year’s cash.

Cover still adequate

Cover would drop to about 1.9 times and would continue the downward trend of recent years, before EPS growth is forecast to come back gradually from 2016. But, in the short term at least, I think that’s good enough. It’s better than rival J Sainsbury‘s forecast cover of 1.8 times for this year — and Morrisons, well, its dividend this year will be in excess of earnings if forecasts are to be believed.

And with Tesco shares having slipped as far as 294p, that 14p per share would represent a handsome yield of 4.9% — there aren’t many in such a relatively safe business paying that much.

So, Tesco’s dividend is under a little pressure after two years of slipping earnings and with a further fall expected. And it may well be cut back a little this year.

You shouldn’t go far wrong

But if you buy Tesco shares at today’s prices, on a P/E of under 11, I think you can be pretty confident of continuing to get dividend yields of around 5% over the next couple of years while you’re waiting for a share price recovery.

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Alan does not own shares in any company mentioned in the article. The Motley Fool owns shares in Tesco.