Pearson (LSE: PSON) andBHP Billiton (LSE: BLT)look to be two of the FTSE 100s most attractive dividend stocks. Both support dividend yieldsof more than 7% and based on historic figures, these payouts are coveredat least once by earnings per share.
However, if a shares dividend yield exceeds that of the wider market, it usually signals that investors arent wholly convinced that the payout is here to stay. The FTSE 100s yield is 4.2%, so it would appear that the majority of traders and investors believePearsonand BHP will be forced to cut their dividend payouts shortly.
And it looks as if the market could be right here.
Short-term relief, long-term pain
Even though Pearson recently announced a drastic restructuring to eliminate4,000 jobs (10% of the companys workforce) in an attempt to safeguard the dividend, it would appear that this action is only atemporaryfix. Indeed, the cuts were announced alongside yet another profit warning from the business. It was thefourth profit warning under chief executive John Fallon and the second time that he has announced a major restructuring plan since taking charge in January 2013.
Pearsons earnings have been falling since2011 when the company reported earnings per share of 86.5p. This year, the company expects to report earnings, excluding some items, of 50p to 55p thats a drop of around 37% in six years. However, since 2011 Pearsons dividend payout has increased by nearly a third. As a result, dividend cover has fallen from twotimes to one.
Unfortunately, now that Pearson is paying out almost all of its earnings to shareholders, its difficult to see how the company will find the cash to invest for growth. As weve seen over the past six years, Pearsons key education market is in structural decline and margins are coming under pressure. So unless the company diversifies away from this business, earnings are likely to trend lower, following wider industry trends and putting the companys dividend under even more pressure.
A cut coming this year?
Its my view that Pearson should suspend its dividend and use the extra cash to invest in growth and BHP may benefit from adopting the same strategy. BHPs shares currently support a yield of 12% and while the companys management has stated that the payout is sustainable, it has also warned that the dividend could be cut to prioritise spending on acquisitions. BHP, the most valuable miner by market capitalisation, should be using its size to swallow smaller peers in the current market. Asset values have slumped as commodity prices fall and BHP should be using its firepower to buy assets at fire sale prices.
BHPs management isstepping up its hunt for acquisitions or new projects. Cutting the groupsannual payout, which cost the miner $6.6bn in its last financial year, would give it moreflexibility to buy mines from rivals or advance some of the projects on its books. Such a move would be a prudent long-term investment strategy and should only benefit long-term investors.
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So overall, it looks as if BHP and Pearson’s dividends might not be as safe as they seem at first glance.If it’s income you seek, there are plenty of top income stocks out there with brighter outlooks than BHP and Pearson.
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