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Are Dividends Built To Last At Tesco PLC And BP 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: Tesco (LSE: TSCO) the supermarket chain and BP (LSE: BP) the oil giant.

Although these firms operate in different sectors both face challenges, yet they still pay a dividend. At the recent share price of 240p, Tesco’s forward yield for 2015 is 0.75%. At 449p, BP’s is 5.8%.

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 managed to maintain at least some kind of payout over the last four years:

Ordinary dividends

2010

2011

2012

2013

2014

2015 (e)

Tesco

13.05p

14.46p

14.76p

14.76p

14.76p

1.8p

BP

13.65p

18.85p

22.1p

24p

25.7p

26p

This table throws Tesco’s problems into sharp relief.  The projected much-reduced payment for the current year shows how bad things are for the company, but we really had some strong clues about what might be coming as Tesco failed to raise its dividend for the last couple of years.

BP is clawing its way back with its dividend since cancelling several quarterly payments during the depths of its 2010 oil-blow-out crisis in the Gulf of Mexico. The payout has advanced by 90% over the period shown, scoring a compound annual growth rate of 17.5% from the rebased level of 2010.

For their dividend records, I’m scoring Tesco 1/5 and BP 3/5

  1. Dividend cover

Tesco expects its 2015 adjusted earnings to cover its dividend more than six times. BP expects earnings to cover its dividend only partially around 0.9 times.

However, 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, Tesco scores 5/5 and BP 0/5.

  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:

Tesco

2010

2011

2012

2013

2014

Operating profit (£m)

3,917

4,182

2,382

2,631

1,327(e)

Net cash from operations (£m)

4,239

4,408

2,837

3,185

?

BP

         

Operating profit ($m)

(9,140)

33,001

14,157

27,803

2,197

Net cash from operations ($m)

13,616

22,154

20,479

21,100

32,754

Tesco’s profits enjoy robust and steady cash flow support; profits might have fallen, but cash flow is sticking full square behind them no matter what. That’s what we’ve always prized in what we once considered a defensive sector with the supermarkets.

BP’s saving grace through recent challenges has always been its gargantuan cash-generating abilities. Although profits cycle up and down, cash flow always seems to thump away in the background. However, BP’s cash performance could suffer if oil prices remain low.

Generally, it seems likely that cash flow could continue to support profits at both firms.

 I’m scoring Tesco 5/5 and BP 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, Tesco’s borrowings stood around ten times the size of its estimated operating profit for 2014, which seems high. That’s a situation brought into focus by the firm’s recent profit collapse. Meanwhile, BP’s debt-load stands around 1.4 times the level of its net cash flow from operations, which appears reasonable.

For their debt positions, Tesco gets 1/5 and BP scores 4/5.

  1. Degree of cyclicality

Tesco’s share price moved from around 437p at the beginning of 2011 to 241p or so today, handing investors a 45% 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.

BP moved from 466p at the start of 2011 to around 450p today, providing investors with a modest 3.4% capital loss, although the share price was volatile over the period because the oil sector is highly cyclical and the firm is still suffering operational drag thanks to the fall-out from the oil spill in the US.

Both firms face uncertain immediate futures thanks to cyclical effects. Tesco trades against the current of a consumer dash to value-delivering competition, and BP just tumbled into a lower oil price environment to compound its Gulf-of-Mexico woes.

Tesco scores 3/5 and BP 1/5.

Putting it all together

Here are the final scores for these firms:

 

Tesco

BP

Dividend record

1

3

Dividend cover

5

0

Cash flow

5

4

Debt

1

4

Degree of cyclicality

3

1

Total score out of 25

15

12

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

Both Tesco and BP have ongoing problems that could drag on investment returns, unlike the firms covered in this Motley Fool wealth report. Our top analysts scoured the market to find companies with reliable cash flow, solid trading positions and great prospects. These are some of the least cyclical firms on the London stock exchange and they offer solid dividend- and capital- growth potential. You can find out more about them by clicking here.

Kevin Godbold 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.