In the past, Tesco (LSE: TSCO) was considered a dividend champion. The company previously had a fantastic long-term dividend growth track record (27 consecutive increases up to 2011), and it also often offered a healthy yield.
However, a little over five years ago, it all started going wrong for the firm. German discounters Aldi and Lidl began aggressively targeting market share, and the company was also involved in an accounting scandal in 2014. Profitability dried up, and in August 2014, the FTSE 100 company announced that it would be cutting its first-half dividend by 75%. Following that, it cut its dividend completely. Needless to say, many income investors were unimpressed.
Yet recently, Tesco has shown signs that it is turning things around. The group reinstated its dividend last year with a small interim payout of 1p per share, and then followed this up with a final payout of 2p per share, taking the FY2018 per share payout to 3p. Then, in October this year, Tesco lifted its interim dividend by an impressive 67% to 1.67p per share.
So what can investors expect from it going forward? Is the stock worth buying for its dividend? Let’s take a look at its 2019 and 2020 dividend forecasts.
Looking at consensus dividend estimates, Tesco is currently forecast to pay out 5.14p per share for the year ending 24 February 2019, and then 7.56p for the next year. At the current share price of 199p, those forecasts equate to prospective yields of 2.6% and 3.8%. So, if analysts are right, the dividend yield could be about to pick up significantly.
However, before you rush to buy Tesco for its dividend, there are things you should know.
The first thing to be aware of is that analysts’ estimates can sometimes be way off the mark, especially if a company does not have a consistent track record of dividend growth. For example, this time last year, analysts were expecting Lloyds Banking Group to pay out approximately 4.1p per share for FY2017. However, Lloyds ended paying out 3.05p – 26% less – and instead, redirecting cash towards a share buyback. Anyone who was hoping for a monster payout was a little disappointed, so don’t take Tesco’s current forecasts as a given.
Second, the dividend payout is likely to be linked to overall profitability. The group said recently that it is targeting coverage (the earnings-to-dividends ratio) of around two times in the medium term. This means is that if earnings fall, the payout could be less. That’s something to be aware of with Brexit around the corner as an economic downturn could drive more shoppers to the discounters.
Third, it’s important to bear in mind that the supermarket landscape is likely to remain highly competitive going forward. Not only are the German discounters turning up the pressure, but the Asda-Sainsbury’s deal could make life difficult for Tesco if it goes through.
Is the stock a good buy for income? Personally, I’m happy to leave it alone for now, given that the supermarket industry is likely to remain highly competitive and Tesco is yet to build up a long-term dividend growth track record after that cut to its payout in recent years. I think there are better income stocks in the FTSE 100 right now.
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Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group and Tesco. 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.