Could Tesco PLC’s Dividend Prospects Face Further Downgrades?

Today I am looking at why I believe Tesco (LSE: TSCO) shareholders should be wary of current dividend forecasts.tesco2

Forecasts poised to fall?

After two years of full-year dividend freezes, the result of enduring pressure on the bottom line has forced Tesco to wake up and finally slash shareholder payouts. The firm made headlines back in August by electing to slash the interim dividend by 75% to just 1.16p per share, commenting that the decision was made in the interests of “maintaining a strong financial position in order to maximise… business and strategic optionality.”

City analysts consequently took the hatchet to their own forecasts, and consensus now points to a total payout of just 6p per share for the year concluding February 2015. This would represent a mammoth 60% drop from the previous year, underpinned by an expected 38% slide in earnings.

And although Tesco is anticipated to punch a further 7% earnings fall in fiscal 2016 — a scenario which would represent a fourth consecutive dip into the red — forecasts suggest that Tesco is likely to lift the full-year dividend 8%, to 6.5p. I believe that these numbers are dubious at best given the absence of a coherent turnaround plan.

Balance sheet on wobbly legs

The crippling extent of lower shopper activity has hammered Tesco’s capital strength in recent times, and the firm has also chopped capital expenditure this year to just £2.1bn, down markedly from the £2.7bn shelled out in fiscal 2014 and down a mammoth £400m from its previous target.

And the Cheshunt-based firm could be in for further gloom once the current investigation into its much-publicised profits overstatement is concluded, a scandal which has attracted the gaze of the Financial Conduct Authority.

The retailer said last month that August’s profit guidance of £1.1bn for the second half could have been bloated by up to £250m. But new chief executive Dave Lewis’ root-and-branch revamp at the firm, which has already seen the suspension of eight high profile executives, could see this quickly-assembled number edge much higher possibly as soon as next week’s interims.

On top of this, Tesco saw net debt remain at a constant, if still sizeable, £6.6bn during the 12 months ending February 2014.

Clearly this could become problematic for the company should shoppers continue to desert the firm in droves, particularly as Tesco also has to service its retirement deficit — indeed, the chain’s post-tax net pension deficit ballooned by £800m to £2.6bn as of the end of last year.

Tesco is quite obviously stuck between a rock and a hard place, and needs to invest vast sums in its operations to mitigate the expansion plans of both the discount and premium sub-sectors. But with shoppers continuing to desert the chain in droves and revenues diving through the floor, I believe that investors should expect further dividend downgrades from the City in the near future as its balance sheet erodes.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.