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Are Lloyds Banking Group PLC & United Utilities Group PLC Great Dividend Picks For 2016 And Beyond?

We’ve seen a number of FTSE 100 firms cut their dividends this year, and City analysts reckon more companies could follow suit in the year ahead.

Today, I’m looking at whether Lloyds (LSE: LLOY) and United Utilities (LSE: UU) could be dividend-disappointers or great picks for 2016 and beyond.

Lloyds

Lloyds’ recovery from the financial crisis and restructuring of its business is beginning to bear fruit. Management said last month that the bank’s “simple, low risk, UK focused business model” and the “robust” UK economy “underpin our continued confidence in generating strong and sustainable returns”.

The table below shows some key earnings and dividend data for the company.

  2012 2013 2014 2015 forecast 2016 forecast
Earnings per share (p) -2.10 6.60 8.10 8.23 7.73
Dividend per share (p) 0.00 0.00 0.75 2.25 3.75
Payout ratio (%) n/a n/a 9 27 49

The earnings per share (EPS) numbers are for “underlying” earnings, and, as you can see, good progress has been made on this measure since 2012. Warts-and-all statutory EPS, isn’t quite as impressive, but did turn positive at 1.7p for 2014, and the company has posted 1.8p for the first nine months of 2015. As the impact of such things as restructuring costs and Payment Protection Insurance provisions fall away, statutory EPS will move closer to underlying EPS.

After the long dividend drought, Lloyds paid a symbolic 0.75p final dividend for 2014. The Board’s aim now is to have “a dividend policy that is both progressive and sustainable … we expect ordinary dividends to increase over the medium term with a dividend payout ratio of at least 50 per cent of sustainable earnings”.

While City analysts expect to see a slight dip in underlying EPS in 2016, the consensus is for a 49% payout ratio, with a dividend at 3.75p, giving a tasty yield of 5.1% at Friday’s closing share price of 73.4p.

Furthermore, with its capital strength and operating efficiency, Lloyds has said: “going forward the Board will give due consideration, subject to the circumstances at the time, to the distribution of surplus capital through the use of special dividends or share buy-backs”.

The stage looks set, then, for Lloyds to be a great dividend pick for 2016 and beyond.

United Utilities

Utilities benefit from the visibility that comes with regulation. In the case of water utilities, such as United Utilities, there are five-year regulatory cycles, the current one being 2014/15- 2019/20.

Therefore, the earnings and dividend data in the table below covers part of the last cycle and part of the current one.

  2012/13 2013/14 2014/15 2015/16 forecast 2016/17 forecast
Earnings per share (p) 38.70 44.70 51.90 47.10 44.90
Dividend per share (p) 34.32 36.04 37.70 38.40 39.20
Payout ratio (%) 89% 81% 73% 82% 87%

As you can see, earnings are forecast to take a bit of a hit as we go into the new cycle, United Utilities telling us that this reflects “the new regulated price controls, an expected increase in depreciation and other costs”.

Nevertheless, management is aiming to increase the dividend by at least RPI inflation each year through to 2019/20. Because the company is in the habit of setting its dividend against the yardstick of inflation (as opposed to earnings), the payout ratio tends to jump about in the short term — though is still consistently higher than most non-regulated businesses. At Friday’s closing share price of 978.5p, United Utilities prospective yield for 2015/16 is 3.9%, rising to 4% for 2016/17.

The 4% yield isn’t particularly great; for example, the company offered over 5% two years ago. Furthermore, United Utilities says that in the new regulatory period its targets are “tough but within reach”,  which sounds like there’s little room for error; and by 2019/20 we could well be in an environment of rising interest rates, which isn’t generally favourable for utilities.

At the end of the regulatory cycle before last United Utilities rebased its dividend 13% lower. The risk of another two-steps-forward-one-step back on the dividend in the current cycle doesn’t appear to me to be sufficiently rewarded by the current yield; and I think there are better picks available than United Utilities.

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