Why SSE PLC And Royal Bank Of Scotland Group plc Are Precarious Dividend Picks

Today I am looking at two firms with murky dividend outlooks: SSE (LSE: SSE) and Royal Bank Of Scotland Group (LSE: RBS) (NYSE: RBS.US).

Electricity play’s dividends set to dim?

Power play Centrica (LSE: CNA) shook the City last week by electing to slash the dividend for the first time in its history.

Crimped by reduced revenues at its British Gas retail arm, Centrica saw adjusted operating profit slip by more than a third to £1.7bn, prompting the supplier to cut the full-year payout for 2014 by 21% to 13.5p per share. Centrica cited the need to bolster its cash position, as well as to maintain a strong credit rating, as the reasons behind the move.

Clearly a number of parallels can be made between SSE and its industry rival. In the face of mounting regulatory pressure and intense competition, the business was forced to cut its tariff 4.1% in January, following hot on the heels of Centrica and its major rivals. SSE will hope the move will help to stop the bleeding across its customer base, which slumped to 8.71m as of the end of 2014 from 9.1m at the end of March.

On top of this, SSE’s balance sheet is also coming under increasing stress, with cash and cash equivalents slumping by more than half as of the end of September, to £244.4m.

And with SSE unlikely to be able to raise prices any time soon in the current climate, shareholders could see payouts come under the cosh this year and beyond.

The number crunchers expect the company to increase the total dividend in the year to March 2015, however, to 89.1p per share from 86.7p last year, creating a yield of 5.8%. A further hike to 91.9p is estimated for fiscal 2016, producing a 6% yield.

But with the bottom line expected to fall 4% and 3% in 2015 and 2016 correspondingly, prospective payments are covered just 1.3 times by earnings, some way short of the security benchmark of 2 times. Although SSE reiterated its intention to “deliver a full-year dividend increase of at least RPI inflation” just last month, the possibility of prolonged earnings weakness could put paid to this strategy.

Don’t bank on payout resumption any time soon

With Royal Bank of Scotland expected to throw up its first profit since the 2008/09 financial crisis in 2015, the City expects the firm to consequently crank its dividend policy back into action. A token payment of 1.6p per share currently chalked in for this year, and payments are expected to stride higher in 2016, with a predicted total dividend of 11.1p carrying a yield of 2.8%.

However, the Royal Bank of Scotland faces a number of challenges which could prevent it from realising these projections. Firstly, the threadbare state of the bank’s balance sheet was exposed in November when it scraped past the European Banking Authority’s stress tests with a capital ratio of 5.7%, marginally beating the regulator’s target of 5.5%.

Clearly Royal Bank of Scotland has a serious need to bulk up its cash pile, but it faces a number of problems that could undermine these efforts. The firm’s restructuring drive continues to eat up capital, while it also faces further impairments and mounting legal penalties — as well as having to shell out vast sums relating to the mis-selling of PPI, the company also faces claims that it misled investors over a 2009 rights issue, as well as accusations that it wrongly sold mortgage-backed securities in the US.

The scale of the bank’s asset-shedding is also casting doubts over the company’s earnings, and consequently dividend, outlook. With its core operations continuing to struggle, Royal Bank of Scotland is expected to see earnings slip 16% this year and 1% in 2016. I believe the prospect of further bottom line pain can be expected in the coming years as revenues struggle to kick into gear.

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