The last few weeks have been challenging for UK dividend investors as a number of high-profile FTSE 100 companies have cut their dividends. First, there was Vodafone, which slashed its payout by 40% in order to deal with its debt pile. Then, Royal Mail also cut its dividend by 40% so that it could free up cash for investment.
Yet neither of these cuts were really surprising, in my view. There were many red flags with Vodafone’s dividend. And in an article on Royal Mail last year, I said: “The profit warning makes me concerned that Royal Mail’s dividend may not be sustainable.”
The bottom line is that when investing for dividends, it’s important to consider a range of factors including dividend coverage, debt, and earnings growth.
For me, Lloyds’ dividend looks sustainable. The stock’s prospective dividend yield is quite high at 5.9% (high yields can be a signal that the market believes a dividend cut is coming) yet not high enough to get me worried about a cut.
One key difference between Lloyds and Vodafone/Royal Mail is that the stock has a much higher dividend coverage ratio. Currently, analysts expect a payout of 3.4p per share from Lloyds for FY2019, while earnings are expected to be 7.8p per share. That equates to a dividend coverage ratio of a healthy 2.3. By contrast, Vodafone had a dividend coverage ratio of 0.99 last year. A ratio under one is unsustainable, while a ratio under 1.5 is a little risky.
Additionally, Lloyds has increased its dividend payout considerably in recent years (three-year dividend growth of 43%). That’s another positive sign. When a company hikes its dividend by that kind of magnitude, it’s a signal management is confident about the future. And analysts expect further dividend growth this year and next, which is also reassuring. Finally, Lloyds appears to have momentum at present. Last year, earnings per share jumped 27%. So overall, I see Lloyds’ dividend as safe for now.
BT’s dividend, on the other hand, concerns me. I have said for a while now I think there’s a real possibility of a cut here. The forward-looking yield of 7.7% is dangerously high, in my view.
While BT’s dividend coverage ratio looks reasonable at 1.6, the lack of dividend growth here is a red flag for me. Quite often you’ll see companies hold their dividend steady for a number of years before finally cutting their payout. For the last three years, BT has paid the same dividend payout of 15.4p per share.
Furthermore, the company has a huge debt pile and pension deficit that it needs to sort out. That’s another classic red flag. Ultimately, it was Vodafone’s escalating debt pile that led to its dividend cut.
Finally, BT is struggling at the moment. For example, full-year results last month showed a 1% fall in revenue and a 6% decline in adjusted earnings per share. That’s not ideal from a dividend investing perspective. Weighing up all these factors, I think there’s a strong chance we will see a dividend cut from BT in the near future.
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Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.