At the time of writing, shares in housebuilder Taylor Wimpey (LSE: TW) are trading under 170p.
Yet according to broker forecasts, the firm is expected to pay a total dividend of 18.2p per share this year. That gives the stock an unlikely dividend yield of 10.8%.
Such a high yield suggests the share price is too low, or that the dividend needs to be cut.
Today I’ll explain what I think will happen and why I wouldn’t expect to double my money with Taylor Wimpey.
Is the dividend sustainable?
The good news is that I’m pretty confident that this year’s dividend will be affordable and will be paid. Big housebuilders such as Taylor Wimpey are generating a lot of spare cash and are returning much of this to shareholders.
For example, in 2018, my sums show that the firm generated free cash flow of £650m. Of this, almost £500m was paid out as dividends.
Management has upped the ante for 2019 and plans to pay out about £600m in dividends this year. However, I’m not convinced that the payout will remain affordable at this level.
2 reasons to worry
Firstly, the company is ploughing money into expansion. The latest accounts show that the order book rose by 10% to 10,137 homes during the first half of the year. The rate of sales also increased.
To fund this growth, management spent an extra £239.9m on land and building during the first half of the year. This caused the group’s net cash balance to fall from £644.1m at the end of 2018 to £392m.
My second concern is that profit margins are falling. Taylor Wimpey’s operating profit margin was 18% during the first half of the year, compared to 20% last year. Land and building costs seem to be rising faster than house prices.
One reason for this could be that the average house price in England and Wales is now 7.8 times average household income, up from 6.7 times in 2013.
The company’s accounts for the 12 months to 30 June show free cash flow of just £415m. A strong cash performance during the second half of this year will be needed in order to achieve a 2019 free cash flow figure of £600m — the amount needed to cover the dividend.
Taylor Wimpey’s net cash balance means that the payout will be affordable. But for dividends to be maintained at this level, the cash balance needs to be replenished, not drained.
It’s also worth noting that the company owes £717.7m to land creditors. This represents land that’s been bought on credit. I see this as a hidden debt.
According to the latest accounts, £354.7m must be paid to land creditors by 30 June 2020. This is another potential drain on cash over the next year.
Are the shares going to double?
Broker forecasts suggest that Taylor Wimpey’s earnings are likely to be almost flat in 2020. Previous forecasts for growth have been slashed.
Given that the company is already paying out about 90% of its earnings as dividends, I don’t see much scope for further dividend growth. Indeed, I think that dividends are probably close to their peak and are likely to fall in the next couple of years.
I don’t expect Taylor Wimpey shares to double, and believe there are better options elsewhere in this sector.
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Roland Head 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.