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Is BT’s almost 7% dividend yield safe?

Are you looking for reliable dividend yields? Let’s look at telecoms company BT Group (LSE: BT.A) to see if the firm can keep up that mighty almost 7% yield.

I reckon businesses are only really worth the cash they can generate from trading and from assets, whether that happens immediately or in the future.

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It also takes cold, hard cash to pay a dividend, and that’s a good reason to focus on cash-generation when trying to work out a firm’s ability to deliver a dividend income for its investors.

Cash and debt

It’s worth keeping an eye on the level of a firm’s borrowings too. Is the company managing its debt well? is it falling, rising or flat? Debt competes with the dividend for the cash the firm generates. High borrowings means big interest payments, which suck the cash away so that not so much of it is available for the dividend.

Sometimes, firms pay dividends and keep pushing them higher even when they really shouldn’t. If debts are high and there’s no free cash left over after paying interest and reinvesting in operations, they shouldn’t pay a dividend. But habits are hard to break and many directors seem to worry about damage to a company’s reputation in the investment community.

But an unvirtuous circle can soon develop with debts rising even higher, maybe because the dividends are really being funded by more borrowings. If you see that kind of situation unfolding, I think it’s a big red flag and the forward dividend payments could be at risk.

If you are caught holding shares in a company that does trim its dividend, you’ll probably suffer a reduced income and capital losses from a falling share price – a double whammy!

The news is a little worrying

BT’s cash flow and debt figures are a little worrying. Operating cash flow has been falling and borrowings have been ballooning up.

Both those indicators are moving in the opposite direction to what we’d want them to in order to support reliable ongoing dividend payments.

Year to March

2015

2016

2017

2018

2019 (e)

Operating cash flow per share

59p

59p

62p

50p

31p

Net borrowings (£m)

5,811

10,847

10,665

10,725

13,279

With the third-quarter trading update in January, BT reported normalised free cash flow of down 11%, which it explained was “mainly driven by increased cash capital expenditure.” But trading was weak, and as for growth, forget it.

The recent dividend record looks like this compared to earnings per share:

Year to March

2015

2016

2017

2018

2019 (e)

Dividend per share

12.4

14

15.4

15.4

15.2

Normalised earnings per share

34

35.3

33.1

29.6

30.2

Growth in the dividend has stalled. The directors have been holding the dividend flat but normalised earnings are lower in the year to March 2019 than they were four years earlier. If earnings continue to decline, I’d expect dividend payments to eventually follow.

BT looks like it has a cheap valuation, but City analysts following the company are not yet predicting any growth in earnings going forward. If that situation doesn’t improve soon, I think the share price and dividend could begin to decline in the years ahead. I see the dividend as insecure.

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Kevin Godbold has no position in any 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.