Are Dividends Safe At Rolls-Royce Holding PLC & Burberry Group plc?

Shares in Rolls-Royce Holding (LSE: RR) are now down by 57% from the high of 1,271p seen at the start of 2014.

Today’s 20% plunge may be the final straw for some investors, especially as the dividend may now be cut.

What’s happened?

Rolls-Royce issued a trading statement on Thursday morning warning that full-year profits for 2015 are expected to be at the lower end of the firm’s guidance.

Things are set to get worse in 2016. Rolls said that falling demand in the civil aviation and the offshore marine markets mean that pre-tax profit for 2016 is now expected to be £650m lower than expected. That’s a cut of around 50% from the firm’s previous guidance of about £1.3bn.

As a result, the firm said this morning that its dividend policy will be placed under review. I’ve taken a look at the latest figures to see whether Rolls can afford to maintain the payout.

Last year’s dividend payout cost about £424m. This year’s payout is expected to remain unchanged, but Rolls is forecasting free cash flow of between -£150m and +£150m for 2015. That means that the firm’s free cash flow definitely won’t cover the dividend.

Rolls has previously said that cash generation will improve in 2016, but I don’t think it’s likely to improve enough to fund the current dividend. I believe a cut is now likely.

Although Rolls has a strong balance sheet with low levels of debt, the firm’s new chief executive, ex-ARM Holdings boss Warren East, may not want to use borrowed money to fund the dividend during such a difficult period.

Mr East said this morning that Rolls’ problems are being made worse by high fixed costs and a lack of flexibility within the business. These issues will be addressed by a new restructuring programme starting next year.

In my view, Rolls could be a long-term buy at current levels, but the income outlook is very uncertain.

Burberry back on track?

Burberry Group (LSE: BRBY) shares have fallen by nearly 30% since February, but the firm’s latest results suggests that the firm’s performance could be stabilising.

Shares in the upmarket fashion brand edged higher this morning after Burberry said that adjusted pre-tax profit rose by 3% to £153m during the first half of the year. The firm’s net cash balance was £459m at the end of the first half, nearly 50% higher than at the same time last year.

There was good news for shareholders, too. Burberry’s interim dividend was increased by 5% to 10.2p. This payout is covered comfortably by first-half adjusted earnings per share of 26.0p.

Market forecasts suggest Burberry will pay a total dividend of 36.5p this year, giving a prospective yield of 2.7%. I’m confident that this payout will be delivered. Burberry’s net cash and strong free cash flow means that unlike at Rolls-Royce, the dividend can be paid from genuine surplus cash.

The second half of the year, which includes Christmas, is a key trading period for Burberry. The firm said today that so far, sales in the third quarter were ahead of those in the second quarter, which seems promising.

On a forecast P/E of 18, I think Burberry shares are reasonably priced at current levels.

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