As commodities producers, the traditional drivers of dividends in the FTSE 100, begin to slash their annual returns to shareholders, where should income investors search for yield? Pearson (LSE: PSON), SSE (LSE: SSE) and Aberdeen Asset Management (LSE: AND) are all offering dividend yields of over 6% currently, but are these the best options for long-term investors?
Publisher Pearson has been undergoing a massive restructuring for more than three years now. After £1.8bn worth of disposals, 5,000 jobs cuts and a further 4,000 on the way, is Pearson finally set to turn a corner? I don’t believe so. Although selling off non-core assets such as The Financial Times and The Economist were wise moves that allowed management to focus on core assets, there’s still no straightforward plan to return to growth. The company has lagged behind other educational providers in digital offerings, which are increasingly replacing traditional physical textbooks in many classrooms. The shift towards digital offerings is increasingly chipping away at Pearson’s competitive moat as any Tom, Dick, or Harry can now publish an e-textbook.
Earnings per share are expected by management to shrink up to 30% in 2016, and a return to significant operating profits isn’t targeted until 2018. While the 7.1% yielding dividend is an eyecatching number, it wasn’t covered by earnings this year and doesn’t looks set to be for next year either. Furthermore, net debt is now a worrying 1.7 times earnings. These data and low growth prospects explain why shares are trading at a relatively cheap 11.6 times forward earnings. For long-term investors, I believe there are income shares out there with much better prospects than Pearson.
Too many problems?
Utility SSE is another company finding it increasingly difficult to fund its dividend, which currently sports a 6.5% yield. While earnings covered the progressive dividend 1.4 times last year, this doesn’t account for the significant infrastructure investment SSE is being forced to undertake as it moves away from coal-powered plants to renewable sources. High capital expenditures on new wind farms and transmission lines mean free cash flow no longer covers dividend payments. This leaves debt markets and paying the dividend in shares (which it has done for five years now) as the only options. Price wars with smaller operators are also heating up, leading to a shrinking customer base and price cuts to keep up with competition. Given these issues, I believe income investors would be much better off with National Grid as their long-term utility share.
Worth a look
Aberdeen Asset Management not only offers the highest dividend of the three, at a mind-boggling 8.85%, but also offers the highest cover at 1.4 times earnings. Aberdeen’s funds have suffered 11 straight quarters of net outflows and this pattern doesn’t look set to be broken anytime soon as its most popular funds are emerging markets-oriented. Furthermore, many of its largest customers are Middle Eastern sovereign wealth funds, which are withdrawing their assets at breakneck speed to support national budgets at home. Despite this grim news, I believe Aberdeen remains a better long-term option than Pearson or SSE. Emerging markets will turn around eventually, and the company boasts an immaculate balance sheet, high margins and a long history of growth through troubled periods. And with shares trading at just 9.5 times forward earnings, buying Aberdeen now could be a great investment years from now.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Aberdeen Asset Management. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.