Is Tesco PLC A Safe Dividend Investment?

Today’s news that Tesco’s (LSE: TSCO) CEO, Philip Clarke, is ‘on his way’ seems like one inevitable outcome from continuing poor trading. Firm’s can’t keep delivering falling sales and profit figures, quarter after quarter, without the top seat feeling increasingly uncomfortable.

TescoCurrent trading conditions are more challenging than anticipated the company says. The overall market is weaker and that has combined with the firm’s emergency investment, aimed at halting the firm’s slide, to produce sales and trading profit below expectations for the first half of the year.

In with the new

So all eyes turn to new recruit Dave Lewis, current president of Unilever’s Personal Care section who will be Tesco’s new CEO from 1 October 2014. Mr Lewis holds a CV stuffed with turnaround experience, which could herald salvation for Tesco’s business and its long-suffering shareholders. Expectations will be high, and to justify the pressure, Tesco will cross Mr Lewis’s palm with pieces of silver, lots of them.

With Tesco’s share price sitting at 291p, it’s down around 35% from its post credit-crunch high of around 450p it achieved in early 2010. So far, despite slipping trading, the firm has managed to keep paying its dividend, as the record shows:

Year to February 2010 2011 2012 2013 2014
Dividend per share 13.05p 14.46p 14.76p 14.76p 14.76p

Although the dividend payment has been flat for the last three years, adjusted earnings covered last year’s payment just over twice, so some slack remains that could see the current year payment held. That said, if the new CEO can’t halt the earnings’ slide, a dividend cut would probably result eventually.

Watch the cash

However, earnings don’t pay the dividend, cash does, and Tesco’s record on cash generation looks like this:

Year to February 2010 2011 2012 2013 2014
Net cash from operations (£m) 4,745 4,239 4,408 2,837 3,185

To put things in perspective, last year’s dividend payments cost the firm £1,189 million, so as long as capex doesn’t draw excessively on cash flow going forward, it seems that even with slipping sales, Tesco has a bit of wiggle room yet, which could see dividends continuing at their current level for a while.

Cash flow is consistent, but margins are thin, which makes profits vulnerable. If disruption to the sector is persistent and long-term, which I think it might be, there could be more downside risk than upside potential with Tesco shares, even from here. If the shares do slide further, capital loss could nullify investor gains from dividend income.

What now?

They say a new broom sweeps clean, and often that means an incoming CEO does a ‘kitchen sinker’, which might even include rebasing a dividend downwards. However, hopes will be high that management finally gets to grips with Tesco’s identity crisis and does actually turn the business around.

Tesco shares currently trade on a forward P/E rating around 11 for 2016 and the forward dividend yield is about 4.9%.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool owns shares of Tesco.