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Are Dividends Built To Last At Wm Morrison Supermarkets plc And Royal Dutch Shell plc?

Some dividends have staying power. Companies delivering enduring dividends tend to back such often-rising payouts with robust business and financial achievement.

Fragile dividends, meanwhile, arise because of weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.

How to tell the difference

Under the spotlight today, two FTSE 100 firms: Wm Morrison Supermarkets (LSE: MRW) the grocery chain and Royal Dutch Shell (LSE: RDSB) the oil giant.

These firms operate in different sectors, but they both have a high dividend yield. At the recent share price of 185p Wm Morrison Supermarkets forward yield for 2015 is 4.8%. At 2222p Royal Dutch Shell’s is 5.6%.

Let’s run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.

  1. Dividend record

Both firms enjoy a decent dividend record:

Ordinary dividends

2010

2011

2012

2013

2014

2015 (e)

Wm Morrison

8.2p

9.6p

10.7p

11.8p

13p

8.9p

Royal Dutch Shell

109.2p

109.2p

111.8p

117p

122.2p

124.3p

Over four years Wm Morrison’s dividend advanced 58%, delivering a compound annual growth rate of 12.2% up to last year. Since then it’s set to fall, rebased down near the level it started at the beginning of the period, thanks to the well-reported troubles in the supermarket sector. Royal Dutch Shell’s moved forward by 12%, scoring a modest growth rate of 2.8% and we’ve yet to see a cut in forward projections.

For their dividend records, I’m scoring Wm Morrison 1/5 and Royal Dutch Shell 2/5

  1. Dividend cover

Wm Morrison expects its 2015 adjusted earnings to cover its dividend around 1.42 times. Royal Dutch shell expects fag-paper-thin cover from earnings of about 1.11 times.

Of course, cash pays dividends, so it’s worth digging deeper into how well, or poorly, both companies cover their dividend payouts with free cash flow — that’s cash flow after maintenance capital expenditure.

On dividend cover from earnings, though, both Wm Morrison and Royal Dutch Shell score 2/5

  1. Cash flow

Dividend cover from earnings means little if cash flow doesn’t support profits.

Here are the firms’ recent records on cash flow compared to profits:

Wm Morrison

2010

2011

2012

2013

2014

Operating profit (£m)

907

904

973

949

(95)

Net cash from operations (£m)

735

898

928

1,107

722

Royal Dutch Shell

         

Operating profit ($m)

26,244

42,715

37,722

26,870

20,159

Net cash from operations ($m)

27,350

36,771

46,140

40,440

45,044

Generally, both businesses see there cash flow support profits, but WM Morrison’s profits dipped as the sector’s problems kicked in.

Looking forward, Wm Morrison may see weakened cash flow thanks to tougher competition, and Royal Dutch shell’s cash performance could suffer if oil prices remain low. However, it seems likely that cash flow could continue to move up and down with profits at both firms.

 I’m scoring both companies 4/5 for their cash flow records.

  1. Debt

Interest payments on borrowed money compete with dividend payments for incoming cash flow. That’s why big debts are undesirable in dividend-led investments.

At the last count, Wm Morrison’s borrowings were around four times the size of its net cash flow from operations, which seems high. Royal Dutch Shell’s, though, were around the same level as its last-reported operating cash flow, which appears reasonable.

For their debt positions, Wm Morrison gets 2/5 and Royal Dutch Shell scores 4/5.

  1. Degree of cyclicality

Wm Morrison’s share price moved from around 270p at the beginning of 2011 to 185p or so today, handing investors a 31% capital loss over the period, which is likely to have reversed any investor gains from dividend income. That’s not so much macro-economic cyclicality at work as a structural change in the industry, which we could consider a much larger cycle in motion.

Royal Dutch Shell moved from 2140p at the start of 2011 to around 2222p today, providing investors with a modest 4% capital gain, although the share price was volatile over the period because the oil sector is highly cyclical.

Both firms face uncertain immediate futures thanks to cyclical effects. Wm Morrison trades against the current of a consumer dash to value-delivering competition, and Royal Dutch Shell just tumbled into a lower oil price environment.

Wm Morrison scores 3/5 and Royal Dutch Shell 1/5

Putting it all together

Here are the final scores for these firms:

 

Wm Morrison

Royal Dutch Shell

Dividend record

1

2

Dividend cover

2

2

Cash flow

4

4

Debt

2

4

Degree of cyclicality

3

1

Total score out of 25

12

13

Neither firm is perfect by these measures, and both face altered trading circumstances going forward, which could affect ongoing dividend performance.

Successful dividend investing may not be as straightforward as it at first seems. However, there is an opportunity to obtain a wealth report prepared by our industry-leading analysts who navigate the dividend-investing minefield every day. Add it to your toolkit now. Click here.

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