Nobody likes a dividend cut. However, with the perilous state of the global economy and the mountain of debt British corporations have accumulated since the last financial crisis, some companies could be dangerously close to slashing their dividends to preserve capital.
In fact, many of the FTSE 100 stocks seem to be spreading themselves too thin in order to deliver a hefty dividend. The index’s dividend coverage ratio (which divides annual earnings by the expected annual payout) is a mere 1.68, which is barely higher than the 1.5 ratio I would consider healthy.
Record-high corporate debt and sparsely covered dividend promises are a recipe for disaster for income-seeking investors. Here are two FTSE 100 dividend heavyweights that I believe are at risk of being unable to cover their hefty dividends next year.
Utility companies should be relatively robust regardless of economic circumstances. However, that’s not the case for British Gas owner Centrica (LSE: CNA), which has already slashed its dividend this year and replaced its chief executive officer.
Earlier this year, only 90% of the company’s planned dividend payout was covered by annual earnings. By the time the management team decided to cut the payout from 12p to 5p — a 58% cut, it was already too late. Centrica’s adjusted earnings and net cash flow from operating activities have dropped 63% and 80% respectively.
That means the new lower dividend is still unsustainable. Meanwhile, the company is grappling with net debt worth £3.4bn. I believe the dividend could be slashed further next year as the company struggles to pay back its debt and cover its 7% dividend simultaneously.
After two decades of rapid dividend growth and consistent performance, Vodafone (LSE: VOD) unfortunately had to cut its dividend earlier this year. It’s a pity to see this former dividend hero’s fall from grace. However, I believe another cut could be imminent.
Vodafone could barely afford its dividend at the start of this year, when earnings covered only 80% of the expected annual payout. However, when Nick Read, the former chief financial officer, took over the role of CEO, he slashed the dividend by 40%. That’s not enough in my opinion.
Vodafone faces tremendous competition across its global markets and must invest heavily over the next few years to stay relevant in the upcoming 5G era. Furthermore, the company also plans to acquire Liberty Global’s cable assets in Germany and some other eastern European markets. This acquisition is being partly financed by debt that will be due in tranches expected in 2021 and 2022.
In other words, if the company cannot turn the ship around over the next few years, it may have to cut the dividend again to cover its hefty (but critical) expenses and the share price rise it has seen in the past month or so could be reversed.
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VisheshR 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.