Are Dividends Built To Last At Tesco PLC And BP plc?

Some dividends have staying power. Companies delivering enduring dividends tend to back such often-rising payouts with robust business and financial achievement.

Fragile dividends, meanwhile, arise because of weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.

How to tell the difference

Under the spotlight today, two FTSE 100 firms: Tesco (LSE: TSCO) the supermarket chain and BP (LSE: BP) the oil giant.

Although these firms operate in different sectors both face challenges, yet they still pay a dividend. At the recent share price of 240p, Tescos forward yield for 2015 is 0.75%. At 449p, BPs is 5.8%.

Lets run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.

1. Dividend record

Both firms managed to maintain at least some kind of payout over the last four years:

This table throws Tescos problems into sharp relief. The projected much-reduced payment for the current year shows how bad things are for the company, but we really had some strong clues about what might be coming as Tesco failed to raise its dividend for the last couple of years.

BP is clawing its way back with its dividend since cancelling several quarterly payments during the depths of its 2010 oil-blow-out crisis in the Gulf of Mexico. The payout has advanced by 90% over the period shown, scoring a compound annual growth rate of 17.5% from the rebased level of 2010.

For their dividend records, Im scoring Tesco 1/5 and BP 3/5

2. Dividend cover

Tesco expects its 2015 adjusted earnings to cover its dividend more than six times. BP expects earnings to cover its dividend only partially around 0.9 times.

However, cash pays dividends, so its worth digging deeper into how well, or poorly, both companies cover their dividend payouts with free cash flow thats cash flow after maintenance capital expenditure.

On dividend cover from earnings, though, Tesco scores 5/5 and BP 0/5.

3. Cash flow

Dividend cover from earnings means little if cash flow doesnt support profits.

Here are the firms recent records on cash flow compared to profits:

Tescos profits enjoy robust and steady cash flow support; profits might have fallen, but cash flow is sticking full square behind them no matter what. Thats what weve always prized in what we once considered a defensive sector with the supermarkets.

BPs saving grace through recent challenges has always been its gargantuan cash-generating abilities. Although profits cycle up and down, cash flow always seems to thump away in the background. However, BPs cash performance could suffer if oil prices remain low.

Generally, it seems likely that cash flow could continue to support profits at both firms.

Im scoring Tesco 5/5 and BP 4/5 for their cash-flow records.

4. Debt

Interest payments on borrowed money compete with dividend payments for incoming cash flow. Thats why big debts are undesirable in dividend-led investments.

At the last count, Tescos borrowings stood around ten times the size of its estimated operating profit for 2014, which seems high. Thats a situation brought into focus by the firms recent profit collapse. Meanwhile, BPs debt-load stands around 1.4 times the level of its net cash flow from operations, which appears reasonable.

For their debt positions, Tesco gets 1/5 and BP scores 4/5.

5. Degree of cyclicality

Tescos share price moved from around 437p at the beginning of 2011 to 241p or so today, handing investors a 45% capital loss over the period, which is likely to have reversed any investor gains from dividend income. Thats not so much macro-economic cyclicality at work as a structural change in the industry, which we could consider a much larger cycle in motion.

BP moved from 466p at the start of 2011 to around 450p today, providing investors with a modest 3.4% capital loss, although the share price was volatile over the period because the oil sector is highly cyclical and the firm is still suffering operational drag thanks to the fall-out from the oil spill in the US.

Both firms face uncertain immediate futures thanks to cyclical effects. Tesco trades against the current of a consumer dash to value-delivering competition, and BP just tumbled into a lower oil price environment to compound its Gulf-of-Mexico woes.

Tesco scores 3/5 and BP 1/5.

Putting it all together

Here are the final scores for these firms:

Neither firm is perfect by these measures, and both face altered trading circumstances going forward, which could affect ongoing dividend performance.