Tesco (LSE: TSCO) and Rolls-Royce (LSE: RR) were once amongst the FTSE 100’s dividend elite. However, in recent years, both companies have fallen from grace in spectacular fashion. Can either stock become a dividend champion in the future? Here are my thoughts.
It wasn’t long ago that Tesco was considered a ‘core holding’ for UK income investors. Looking back to 2011, the retailer had increased its dividend for 27 consecutive years, an impressive achievement. Furthermore, the yield was attractive, often just under the 4% mark.
However, the supermarket landscape changed dramatically several years ago when the German discounters began aggressively targeting market share. Profits at the big four traditional supermarkets nosedived dramatically. As a result, Tesco was forced to cut its payout.
The good news for income investors, is that it recently reinstated its dividend. Don’t get too excited just yet however as the payout wasn’t huge. Investors received a half-year payout of 1p per share on 24 November. Looking forward, City analysts forecast a full-year FY2018 payout of 3.28p, a yield of 1.6% at the current price.
For FY2019, analysts expect the dividend to increase to 5.19p. While that’s certainly a progression, it still only represents a yield of 2.6% at today’s share price. Slightly underwhelming in my view.
Will Tesco ever have a strong yield again? I’m not so sure. On the plus side, dividend coverage now looks quite looks healthy, indicating room for further growth. On the downside, the supermarket landscape is likely to remain extremely challenging. Lidl and Aldi are still growing at an incredible speed. All in all, I think there are better dividend stocks out there right now.
Like Tesco, it was only a few years ago that Rolls-Royce was considered to be a dividend star. Up to FY2014, the engineering specialist had recorded nine consecutive dividend rises, with the payout rising 180% over that period. However, in recent years, it’s been a different story. Rolls has cut its dividend by 29% per year over the last two years. Last year’s payout of 11.7p was a yield of just 1.4% at the current share price. Hard to retire early on that kind of payout.
So what does the future hold? Can the engine maker get back to dividend champion status?
Unfortunately, in the short-to-medium term, the outlook for income investors doesn’t look great. While the company stated in February that over the long term, its objective is to “progressively rebuild” its dividend to an “appropriate level,” it also said that this is subject to the short-term cash needs of the business.
And that’s the problem. Rolls just doesn’t have the cash resources to pay big dividend rights now. For example, for the first half of this year, free cash flow (operating cash after capital expenditure, pensions and taxes, before payments to shareholders) was -£339m. That’s clearly not ideal. Companies require cash to pay their shareholders dividends. It’s as simple as that.
Looking at broker estimates, Rolls is expected to pay dividends of 12.3p this year and 13.7p next year. Those payouts equate to yields of just 1.5% and 1.6%. Given the attractive yields on offer from many other FTSE 100 companies right now, those payouts don’t look attractive to me. Income investors should look elsewhere for large dividends, in my opinion.
Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.