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Thinking of buying Taylor Wimpey’s 12% dividend yield? Read this first

Concerns about the state of the UK housing market have sent shares in Taylor Wimpey (LSE: TW) plunging this year. After hitting a five-year high of just under 200p on January 1, shares in the company have steadily lost value and are now changing hands for just under 150p.

Dividend yields move in the opposite direction to share prices, so as Taylor’s stock has slumped, its yield has surged and now sits at 12% (on a forward basis), making it the highest yielding stock in the FTSE 100.

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But before you buy the homebuilder for its income credentials, I think there are several things you should know about the business.

Falling demand

After several years of rising home sales, Taylor’s management recently warned that next year, the volume of houses sold by the group is expected to be “broadly flat in current market conditions.

However, management is also confident that “with a very real underlying need for more homes in the UK,” there is “potential for significant growth from 2020 onwards.

Cash balance

According to the company’s latest trading update, management expects to end 2018 with “a net cash balance of around £600m,” although this is “subject to the timing of conditional land purchases” it is still a sizeable sum.

That being said, at the current rate, Taylor’s dividend commitments are costing the company big time. For 2018 as a whole, management expects a cash outflow from dividends of £500m. For 2018, the business distributed 15.5p per share giving a yield of 10.5%. For 2019, analysts are forecasting a distribution of 18.1p per share for a yield of 12.2%.

In my opinion, a cash balance of £600m, combined with operating income over the next 12 months, should cover the distribution next year, but I’m not sure about the payout’s sustainability after 2019. If the housing market slows further, Taylor may have to reduce its dividend.

Rising costs 

Another threat to the payout is rising costs. Taylor’s management expects build costs to “increase 3%-4% this year” due to cost inflation across the industry. Analysts believe this trend will continue as the UK detaches itself from the EU as the supply of low-cost labour dries up. 

With house prices falling, rising costs will squeeze Taylor’s profit margins as the business will be unable to raise selling costs to compensate. While I don’t believe this will translate into a significant headwind for the group, I think it is just one of several factors that may cause management to reconsider the current level of the dividend. 

The bottom line 

So overall, I reckon Taylor’s 12.2% dividend yield is safe for the time being, but a lot rests on whether or not demand for homes picks up in 2020 as the company’s management predicts. If not, and cost inflation increases, then the firm might struggle to produce the £500m+ per annum in cash required to sustain the dividend at its current level. 

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Rupert Hargreaves owns no share 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.