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Don’t bank on these 6% dividend yields to deliver a large retirement income

Pendragon (LSE: PDG) has seen its share price fall around 20% over the past year as demand for new cars has steadily evaporated.

I would argue that the rate at which auto sales are slumping should have produced an even larger decline, and believe that a sharp shock lower could be just around the corner.

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The Society of Motoring Manufacturers and Traders (SMMT) underlined the worrying state of the new car market on Thursday with news of a 3.5% drop in new vehicle sales in June. In the six months to last month, total volumes were down 6.3% from the corresponding period last year, at 1.31m units.

It’s no surprise that Pendragon is struggling in this situation. It endured a 13.3% drop in new vehicle revenues during January-March and gross profit from new cars careered 17.6% lower year-on-year. Therefore, underlying group pre-tax profit more than halved during Q1 to £15.1m, in spite of massive cost-cutting that resulted in savings of £3.9m.

In a spin

City analysts are expecting earnings to edge 3% higher in 2018 before the rate of improvement increases to 14% next year. Pendragon may be expecting sales to pick up during the latter half of the year, thanks to weak comparatives in the corresponding 2017 timespan. I am not convinced though, given the mounting pressure on Britons’ spending power that should keep hammering car sales. Thus, a low forward P/E ratio of 7.2 times has no appeal to me at least.

I am concerned by this, as well as the impact of Pendragon’s swelling debt pile on future dividends. Sure, the car retailer may not be hamstrung by debt, but the rate at which loans have risen should make any income investor sit up and take notice. This jumped £32.4m last year to stand at £124.1m as of December.

The anticipated dividend freeze through to the end of next year, at 1.55p per share, therefore may be considered a tad optimistic. And so investors should put little faith in the company’s bulky 6.4% yield.

Out of date?

The Restaurant Group (LSE: RTN) is another big-yielding share I reckon could fail to meet lofty dividend expectations.

City brokers are expecting the Frankie & Benny’s owner to succumb to sustained earnings woes and cut the dividend in 2018 (an extra 5% profits reverse is forecast for this year). The business has kept the payout level at 17.4p per share for the past three periods, but is expected to reduce it to 16.8p.

On the plus side, the yield stands at a mighty 6%. And glass-half-full investors will also point to Square Mile predictions of a 7% earnings recovery next year, and a subsequent dividend raise to 16.9p (yielding 6.1%) as reasons to be optimistic.

Latest trading details showed like-for-like sales ducked 4.3% during the 20 weeks to May 20, keeping the relentless run of disappointing releases coming. And with the environment becoming tougher amid constrained consumer spending power and intense competition, and cost inflation adding another problem, I believe a bigger dividend reduction could be in the offing.

What’s more, a forward P/E ratio of 13.1 times isn’t that compelling either when you consider that The Restaurant Group’s turnaround strategy is still failing to fire. And the risks  for the company’s retail park-based restaurants are growing as the e-commerce boom continues. There are many other big-yielding shares with better investment potential than this one, in my opinion. Speaking of which…

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Pendragon. 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.