Lately, Ive been running some tests to gauge business and financial quality to see if dividends seem built-to-last at some popular FTSE 100 companies.
Of the firms looked at, Unilever (LSE: ULVR), Diageo (LSE: DGE) and Tesco (LSE: TSCO) scored the highest and heres why:
Dividend records
A decent dividend record is one factor to consider, although what happens in the future is what really counts. Of the three firms, Tesco stands out with its sorry record on dividend payments a flat payout for three years followed by a recent dividend cut and downwards rebasing.
Tescos dividend record is poor, yet the firm still scored amongst the highest overall. Read on to find out why.
Over the last four years, Unilevers dividend advanced 27% chalking up a compound annual growth rate (CAGR) of 6%. Diageos dividend increased by 36% over the same period posting a CAGR of 7.9%.
For their dividend records, I scored both Unilever and Diageo 3/5 and Tesco 1/5.
Dividend cover
Diageo expects cover from earnings of about 1.7 times, Unilever around 1.45 times and Tesco expects its 2015 adjusted earnings to cover its dividend more than six times.
My ideal dividend payer would cover its cash distribution with earnings at least twice. However, cash pays dividends, so its worth digging into how well, or poorly, the three companies cover their dividend payouts with free cash flow thats cash flow after maintenance capital expenditure.
On dividend cover from earnings, though, Diageo scored 3/5, Unilever 2/5 and Tesco 5/5.
Cash generation
Dividend cover from earnings doesnt help pay dividends if cash flow doesnt support profits.
Tescos profits still enjoy robust and steady cash flow support despite recent challenges; profits might have fallen, but cash-generation backs up the reduced result. Thats one reason weve always considered the supermarket sector defensive.
Diageos consumer goods business, with its repeat-purchase attractions, delivers steady cash flow that generally supports profits. Over the last three years, though, the cash supply from operations tailed off somewhat.
Meanwhile, Unilevers consumer-products-driven cash flow follows profits quite well, although it, too, dwindled over the last two years.
For their ability to generate steady flows of cash to support dividend payments Diageo and Unilever scored 3/5 and Tesco 5/5.
Debt
Firms cant pay big dividends if most of their free cash flow goes to service big borrowings. Thats why big debts are undesirable in dividend-led investments.
Diageo uses a fair amount of other-peoples money. The firms borrowings run in excess of four times the level of operating profit. Unilever runs borrowings at around 1.6 times the level of operating profit and, at the last count Tescos borrowings stood around ten times the size of its estimated operating profit for 2014, which seems high. Tescos debt situation comes into sharp focus due to the firms recent collapse in profits.
For their circumstances around debt, Diageo scored 2/5, Unilever 4/5 and Tesco 1/5.
Degree of cyclicality
Tescos share price moved from around 437p at the beginning of 2011 to 243p or so today, leaving investors with a 44% capital loss. Such reversals will likely have wiped out gains from dividend income. Structural change in the industry drove the shares more than macro-economic cyclicality, which we could see as a much larger cycle playing out.
Diageo and Unilever, both consumer-goods champions, see far less cyclicality in their business performance than many other industries. Arguably, Diageos market in addictive sin products makes it even more immune from cyclicality.
For their exposure to cyclical effects I scored Tesco and Unilever 3/5 and Diageo 4/5.
The final reckoning
The overall scores are interesting. All three firms scored 15 out of a possible 25, but they achieved those scores in different ways.
Unilever |
Diageo |
Tesco |
|
Dividend record |
3 |
3 |
1 |
Dividend cover |
2 |
3 |
5 |
Cash generation |
3 |
3 |
5 |
Debt |
4 |
2 |
1 |
Degree of cyclicality |
3 |
4 |
3 |
Total score out of 25 |
15 |
15 |
15 |
None of these companies is perfect by these measures, but they are the highest scorers of those I looked at.
This analysis makes for a reasonable start for research but please don’t leave it at that. I urge you to look deeper before committing funds to the shares of Unilever, Diageo or Tesco. There’s more to picking a robust dividend payer than choosing the highest dividend yield, that’s for sure. Successful dividend investing may not be as straightforward as it at first seems. However, there is an opportunity to obtain a wealth report prepared by our industry-leading analysts who navigate the dividend-investing minefield every day. Add it to your toolkit now byclicking here.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco and Unilever. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.