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Is this massive dividend yield in danger of being cut?

Crest Nicholson (LSE: CRST) shares have been doing pretty well, all things considered. Over one year they’ve gained around 13% and, despite a 12% drop in the last month, they’re still up very slightly over the course of 2020 so far.

So, the shares have some momentum – likely as a result of housebuilders generally being so undervalued, as I’ve argued before. This situation is the result of a combination of issues relating to sector executive pay, investigations into build quality, fears about the end of help to buy, economic worries, and Brexit. That’s quite a list to be contending with. But the depressed share prices of housebuilders has tended to push up their dividend yields. 

The dividend

Crest Nicholson has a massive 8% dividend yield. The problem now is that the dividend is not growing and the dividend cover – which historically has been good, at around two – is now falling. 

If earnings continue to fall at Crest Nicholson, there’s a real danger that at some point in the coming years the bumper payout may have to be cut. Usually, that also results in a short-term plummet in the share price – especially if the dividend yield is one of the main reason investors want to own the shares – as is probably the case with Crest Nicholson.

What do its results show

Preliminary results announced for the year ended 31 October 2019 showed pre-tax profits tumbled 39% to £102.7m. This fell short of the guidance of £120-130m it issued following last October’s profit warning.

The group is also battling with falling margins. These declined from 16.2% to 12.2%. It means they are well below those of rivals such as Persimmon. On the flip side, it gives management room for improvement which could filter into better earnings in future.

Crest Nicholson, which mainly operates in London and the South East of England, noted that house prices had fallen in its territories since the 2016 EU referendum. Overall, though, this seems an attractive part of the market to be in in the long term. House prices historically have tended to rise in these regions.

Risk of a cut

In the short term, I think the risk of a cut has got to be considered a very real possibility. It’s good to see that management has held the dividend at the same level – perhaps delaying the need for a cut and giving it time to improve the business.

I think investing in Crest Nicholson based on the yield alone is not enough. It’d be much better to look for a slightly lower overall yield but one that is still growing and well covered by earnings. To invest now you need to have confidence that Crest Nicholson can up its margins and avoid any further profit warnings. Otherwise the share price is likely to fall.

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Andy Ross owns shares in Persimmon. 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.