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Why SSE isn’t the only 6%+ yielder that could damage your retirement income

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Today I want to look at two popular FTSE 100 high-yield stocks which could be heading for a dividend cut.

The first company on my radar is utility giant SSE (LSE: SSE). This business has increased its dividend every year since at least 1993. Unfortunately this tradition is about to be broken.

In May the company revealed plans to cut its annual dividend from 97.5p per share in 2018/19 to 80p per share in the 2019/20 financial year.

The cut is needed because the group is in the process of combining its retail business with that of Npower, to form a new company. Last year, SSE’s retail division generated £402.8m of a total operating profit of £1,828.7m. So profits are likely to be significantly lower after this demerger.

This dividend cut will reduce the forecast yield from 7.6% to 6.2%. Shareholders won’t necessarily lose out, receiving one share in the new company for each SSE share they own. I expect the new retail energy business to also pay a dividend. So the yield from the two stocks may well remain unchanged.

SSE could be a buy

Over the last two years, my calculations show SSE paid out £1,263.2m in dividends, but only generated £751.7m in free cash flow, the shortfall made up with £890.8m of proceeds from asset sales during the period.

Although acquisitions and disposals are a normal part of the business, I think the scale of this cash shortfall suggests that the dividend was becoming stretched. A reduced payout should provide a more affordable base for future dividend growth.

SSE shares look quite cheap on 10.5 times forecast earnings. But it’s not completely clear to me how its finances will look after the spin-off, which might still be blocked by the regulator. I plan to wait for the dust to settle before deciding whether to buy.

This 6.8% yield is under pressure

At FTSE 250 pub chain Greene King (LSE: GNK), chief executive Rooney Anand has no intention of cutting his firm’s dividend. But not all investors share this confidence.

He is keen to point out that the company has a track record of generating enough cash to cover interest costs, core capital expenditure and the dividend, without selling any pubs.

Unfortunately this track record is looking shaky. In 2016/17, I calculate that free cash flow before disposals was £104.3m — just enough to cover dividend payments of £100.1m.

In 2017/18, free cash flow before disposals fell to £72.3m. That wasn’t enough to cover last year’s payout of £102.9m. Extra cash from disposals was needed to make the payout affordable.

Bargain or value trap?

Mr Anand expects market conditions “to remain challenging for some time”. My concern is that if earnings continue to fall, he could find it harder to service the £2,032m net debt.

Greene King’s earnings before interest, tax, depreciation and amortisation (EBITDA) fell by 7% to £486.6m last year, lifting the net debt-to-EBITDA ratio from 4 times to 4.2 times.

This already looks high relative to sector peer J D Wetherspoon, on a ratio of 3.5 times. But my calculations suggest that if EBITDA falls by a further 7% this year, the ratio could reach 4.5 times. I’d view this as uncomfortably high.

Greene King could be a turnaround buy at current levels. But I’m waiting for evidence that trading has stabilised before making my decision.

Buy-And-Hold Investing

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Roland Head 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.