Morrisons’ (LSE: MRW) shares currently support a dividend yield of 6.8%, offering a level of income you’d be hard pressed to find elsewhere.
However, there’s no guarantee that this payout is here to stay and investors should be prepared for the worst.
According to Morrisons’ cash flow statements, the company’s dividend payout cost a total of £283m last year. Dividends issued during 2014 totalled 13p per share, an average yield of 5.4%.
Under Morrisons’ old management, this payout was considered to be gold-plated. Now a new management team is moving into place, they could reconsider this dividend strategy.
It is clear that the supermarket sector as a whole is under pressure and the figures show that Morrisons isn’t doing any better than its larger peers. For example, Morrisons’ earnings before interest, tax, amortisation and depreciation margin is set to fall to 5.1% this year. Peers, Tesco and Sainsbury’s are expected to report EBITDA margins of 4.8% and 5.5% respectively.
Moreover, Morrisons actually has the highest debt level of its peers. The group’s net debt to EBITDA ratio is set to hit 2.7x this year, compared to Sainsbury’s ratio of 1.8x and Tesco’s ratio of 3.2 — Tesco is currently weighing up the sale of assets worth more than £5bn which will drastically reduce debt.
That being said, Morrisons is planning to generate £2bn of cash and £1bn of cost savings over three years, which should help to pay down debt. However, by cutting the dividend payout by 50%, the group could save £140m per annum or £420m over three years — a significant sum.
And when you consider the fact that Morrisons is planning to spend £1bn cutting prices over the next three years, additional savings of £140m per annum could be a game changer for the company.
Indeed, if management were to cut the dividend by 50%, and plough the cash saved into additional price cuts, the company could increase its price cutting budget by 42%.
Morrisons has already committed the most cash to price cuts out of the big three supermarkets. An additional £420m would blow competitors out of the market.
A 50% cut in the dividend would mean that Morrisons annual payout fell to 6.50p per share, a yield of 3.4% based on current prices — similar to the FTSE 100‘s average dividend yield of 3.2%.
The bottom line
Overall, with the supermarket sector in crisis, Morrisons’ lofty dividend yield of 6.8% seems excessive and the company would benefit from a dividend cut.
Morrisons’ previous management made a commitment to the payout but now the group is about to be taken over by a new management team, all bets are off. The new management team could decide that a dividend cut is the best course of action for the company.
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Rupert Hargreaves owns shares of Tesco. 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.