Inflation is on the rise in the UK, which means stocks offering high dividend yields could become increasingly popular with investors. There’s no shortage of high yields to choose from in the FTSE 100 but if you back a stock that cuts its dividend, it rather defeats the object.
With this in mind, I’m looking today at one blue chip I trust to deliver on its dividend and one I believe could disappoint.
Marks & Spencer(LSE: MKS) paid a dividend of 18.7p for its last financial year, giving a trailing yield of 5.5% at a current share price of 337p. On the face of it, this looks attractive, particularly as the payout was covered a healthy 1.9 times by underlying earnings per share (EPS) of 35p.
However, I believe there are good reasons to view M&S’s dividend as under threat and, personally, I see this as a stock to avoid.
So far in the 21st century, M&S has announced two rounds of dividend cuts — by 37.5% in 2000 and 33.3% in 2009. The table below shows some of the key financials at the time these cuts were announced, as well as forecasts for the current year.
RevenueUnderlying pre-tax profitUnderlying EPSStatutory EPSNet debtDividend23 May 2000£8.2bn£557m13.2p9p£1.25bncut to 9p from 14.4p19 May 2009£9.1bn£604m28p32.2p£2.49bncut to 15p from 22.5p24 May 2017£10.6bn£592m28.8p? (1p in H1)? (2.24bn at end H1)? from 18.7p
In 2000, chief executive Peter Salsbury was confident his transformation plan for M&S would "achieve a sustainable recovery" but rebased the dividend to make the necessary investment in the business.
In 2009, chief executive Stuart Rose was confident his five-year ‘change programme’ would achieve "stronger foundations for long-term growth" but rebased the dividend to make the necessary investment in the business.
Today, chief executive Steve Rowe has just embarked on a multi-year transformation "to build a long-term sustainable business". It will require investment and have "an adverse effect on profit in the short term".
M&S’s current policy is to pay a dividend broadly twice covered by underlying EPS. If, when it announces its results on 24 May, it were to maintain the dividend at last year’s 18.7p, cover would fall to just 1.5, based on forecast underlying EPS of 28.8p.
Given the need to invest in the transformation plan and Brexit-related pressures on trading, I wouldn’t be at all surprised to see the past repeat itself and the dividend rebased. Two times cover by underlying EPS would see a cut to 14.4p — back to the level of 18 years ago and giving a yield for the current year of 4.3%
I believe there’s a much brighter outlook for the dividend of tobacco group Imperial Brands(LSE: IMB). The board has increased the payout by 10% for eight consecutive years and is committed to further annual 10% increases "over the medium term". This would give a yield of 4.4% for the current year, rising to 4.9% next year.
In contrast to the cyclical M&S, which seems forever to be undergoing a costly transformation programme, Imperial Brands is in an industry with highly attractive economics and is one of the most solid, defensive businesses around. I’d take the tobacco group’s dividend over M&S’s any day of the week but particularly right now with the retailer giving me dividend-cut déjà vu.
I reckon the defensive qualities and strong dividend prospects of Imperial Brands make it a canny investment today. But has it made the cut for an elite group of FTSE 100 companies the Motley Fool’s experts have identified as 5 Stocks To Retire On?
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Imperial Brands. 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.