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Saga plc isn’t the only dividend stock on the danger list

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Shares of TalkTalk (LSE: TALK) plunged as much as 18% when the market opened this morning after the FTSE 250 firm issued a profit warning and slashed its dividend. It’s also raising up to £200m from investors — in progress as I’m writing — to shore up its balance sheet and fund a new full-fibre broadband rollout.

Talking profits, dividends and debt

TalkTalk said full-year earnings before interest, tax, depreciation and amortisation (EBITDA) would now be between £230m and £245m, down from the £270m to £300m it had guided on in November.

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After paying a dividend of 10.29p last year, the board is “temporarily” cutting the payout to 2.5p per annum, before moving to a base of 7.5p “when leverage is reduced to 2 times EBITDA.”

TalkTalk had net debt of £837m at the last reckoning. The fundraising of up to £200m will reduce debt by £100m, with the other £100m earmarked for a 20% stake in a new joint venture with Infracapital to provide full fibre to more than 3m homes and businesses. I make the pro forma leverage 3.1 tines EBITDA, so I reckon the 2.5p dividend could be around for at least a couple of years — even if things go well.

Difference of opinion

Ahead of today’s update analysts were somewhat divided on the company’s prospects. Exane BNP Paribas argued that the company, which reset its strategy last year, is struggling to compete at the value end of the market. It expected a dividend cut and slapped a 90p price target on the shares. RBC thought concerns about the company were overdone and upgraded the stock to ‘outperform’, albeit lowering its price target to 150p from 190p.

The shares have regained some ground since early morning and are currently trading 10% down at 108p, which gives a dividend yield of 2.3%. I lean more towards the Exane view of TalkTalk’s business prospects and with the dividend also slashed, I rate the stock a ‘sell’.

Turnaround saga

Saga (LSE: SAGA) is another FTSE 250 company whose strategy is looking shaky, after it issued a profit warning in December. The collapse of Monarch Airlines was part of the reason, but a sharp deterioration in its insurance broking business (55% of group profit) is more worrying.

Management is confident of turning the business round. Indeed, despite net debt of £460m and leverage of 1.8 times EBITDA at the last half-year end, the board said it remains fully committed to continuing its progressive dividend policy.

However, some analysts question whether Saga’s broking issues are more structural and if we’re looking at an ex-growth business, while a dividend yield of 7.6% at a current share price of 117p suggests the market isn’t entirely convinced the payout is safe.

I share the concerns of the doubtful analysts about the broking business and the market’s concerns about the dividend. And bearing in mind the old adage that profit warnings come in threes, I’m avoiding Saga at this stage. I’d rather pay a bit more for the shares later if the company can demonstrate a turnaround is beginning to happen.

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G A Chester has no position in any of the 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.

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