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Two 5%+ yields I wouldn’t touch with a bargepole

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As the turmoil surrounding the UK retail sector continues I cannot help but believe that DFS Furniture (LSE: DFS) remains a risk too far today.

British retail performance has been far from convincing of late, but it would have been even worse had it not been for solid figures from the grocery segment. Indeed, the latest retail sales monitor from the British Retail Consortium and KPMG last week underlined the stress facing sellers of non-edible goods, the gauge revealing that like-for-like sales of non-food items fell 1.8% during the three months to March.

Sofa seller struggling

This tough environment was underlined by DFS’s latest financial update in late March in which it revealed that, stripping out the impact of its Sofology acquisition, revenues had dropped 3.5% during the six months to January to £366.5m.

Reflecting the worsening trading landscape, the City is expecting DFS to print a 4% earnings drop in the year to July 2018. And this — combined with its ballooning debt pile as net debt surged to £172.3m as of November January from £135.6m earlier due to the aforementioned M&A activity — is predicted to put paid to the firm’s progressive dividend policy.

Indeed, fiscal 2017’s ordinary dividend of 11.2p per share is expected to remain on hold in the current year. Some investors may still be drawn in by a still-mountainous 5.3% yield, while City predictions of an 11% earnings bounceback next year (and subsequent lifting of the dividend to 11.4p and a consequent 5.4% yield) may tempt more dip buyers to nip in.

I do not think this is advisable, however. Sure, DFS may have kept the interim payout on hold at 3.7p per share last month. But I believe a reduction cannot be ruled out in the full-year payout as the troubles on the high street intensify and particularly as projected dividends are covered just 1.6 times by predicted earnings, some way below the accepted safety benchmark of 2 times.

I would ignore the huge yields and cheap forward P/E ratio of 11.7 times. The company simply carries too much risk right now.

Sales sliding

The murky outlook for the UK retail sector also makes me more than a little concerned over the dividend outlook of The Restaurant Group (LSE: RTN).

The Frankie & Benny’s and Chiquito owner may well have thrown a fortune at revamping its menus. But City analysts do not expect this to propel The Restaurant Group back into profits growth just yet — a 5% earnings reversal is predicted for 2018.

And so the company is finally tipped to reduce the dividend after three years of keeping it at 17.4p per share. A payout of 16p is forecast for this year 

Supported by predictions of a 6% earnings improvement in 2019, glass-half-full investors will point to expectations that dividends are expected to rise again to 16.3p as a reason to be cheerful.

However, the steady sales slide over at The Restaurant Group shows no signs of slowing (like-for-like sales across its chains fell 3% during 2017), and this makes me, for one, highly doubtful of an earnings uplift any time soon.

I would ignore The Restaurant Group’s meaty yields of 5.7% and 5.8% for 2018 and 2019 respectively, as well as its low forward P/E ratio of 13.1 times and steer well clear, as the chances of sustained profit and dividend disappointment are high.

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Royston Wild 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.