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3 Of The Safest Dividends In The FTSE 100: Unilever plc, Diageo plc And Tesco PLC

Lately, I’ve been running some tests to gauge business and financial quality to see if dividends seem built-to-last at some popular FTSE 100 companies.

Of the firms looked at, Unilever (LSE: ULVR), Diageo (LSE: DGE) and Tesco (LSE: TSCO) scored the highest and here’s why:

Dividend records

A decent dividend record is one factor to consider, although what happens in the future is what really counts. Of the three firms, Tesco stands out with its sorry record on dividend payments — a flat payout for three years followed by a recent dividend cut and downwards rebasing.

Tesco’s dividend record is poor, yet the firm still scored amongst the highest overall. Read on to find out why.

Over the last four years, Unilever’s dividend advanced 27% chalking up a compound annual growth rate (CAGR) of 6%. Diageo’s dividend increased by 36% over the same period posting a CAGR of 7.9%.

For their dividend records, I scored both Unilever and Diageo 3/5 and Tesco 1/5.

Dividend cover

Diageo expects cover from earnings of about 1.7 times, Unilever around 1.45 times and  Tesco expects its 2015 adjusted earnings to cover its dividend more than six times.

My ‘ideal’ dividend payer would cover its cash distribution with earnings at least twice. However, cash pays dividends, so it’s worth digging into how well, or poorly, the three companies cover their dividend payouts with free cash flow — that’s cash flow after maintenance capital expenditure.

On dividend cover from earnings, though,  Diageo scored 3/5, Unilever 2/5 and Tesco 5/5.

Cash generation

Dividend cover from earnings doesn’t help pay dividends if cash flow doesn’t support profits.

Tesco’s profits still enjoy robust and steady cash flow support despite recent challenges; profits might have fallen, but cash-generation backs up the reduced result. That’s one reason we’ve always considered the supermarket sector defensive.  

Diageo’s consumer goods business, with its repeat-purchase attractions, delivers steady cash flow that generally supports profits. Over the last three years, though, the cash supply from operations tailed off somewhat.

Meanwhile, Unilever’s consumer-products-driven cash flow follows profits quite well, although it, too, dwindled over the last two years.

For their ability to generate steady flows of cash to support dividend payments Diageo and Unilever scored 3/5 and Tesco 5/5.

Debt

Firms can’t pay big dividends if most of their free cash flow goes to service big borrowings. That’s why big debts are undesirable in dividend-led investments.

Diageo uses a fair amount of other-people’s money. The firm’s borrowings run in excess of four times the level of operating profit. Unilever runs borrowings at around 1.6 times the level of operating profit and, at the last count Tesco’s borrowings stood around ten times the size of its estimated operating profit for 2014, which seems high. Tesco’s debt situation comes into sharp focus due to the firm’s recent collapse in profits.

For their circumstances around debt, Diageo scored 2/5, Unilever 4/5 and Tesco 1/5.

Degree of cyclicality

Tesco’s share price moved from around 437p at the beginning of 2011 to 243p or so today, leaving investors with a 44% capital loss. Such reversals will likely have wiped out gains from dividend income. Structural change in the industry drove the shares more than macro-economic cyclicality, which we could see as a much larger cycle playing out.

Diageo and Unilever, both consumer-goods champions, see far less cyclicality in their business performance than many other industries. Arguably, Diageo’s market in addictive ‘sin’ products makes it even more immune from cyclicality.

For their exposure to cyclical effects I scored Tesco and Unilever 3/5 and Diageo 4/5.

The final reckoning

The overall scores are interesting. All three firms scored 15 out of a possible 25, but they achieved those scores in different ways.

 

Unilever

Diageo

Tesco

Dividend record

3

3

1

Dividend cover

2

3

5

Cash generation

3

3

5

Debt

4

2

1

Degree of cyclicality

3

4

3

Total score out of 25

15

15

15

None of these companies is perfect by these measures, but they are the highest scorers of those I looked at.

This analysis makes for a reasonable start for research but please don't leave it at that. I urge you to look deeper before committing funds to the shares of Unilever, Diageo or Tesco. There's more to picking a robust dividend payer than choosing the highest dividend yield, that's for sure. 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 by clicking here.

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