Will the supermarkets dividends fall like dominoes after Tescos announcement of a 75% cut to its interim payout last Friday?
In particular, will Wm. Morrison Supermarkets which many investors thought was more vulnerable to a cut than Tesco similarly slash its payout when its half-year results are released next week?
Well, I think Morrisons might just defy the dividend doomsters!
Am I mad?
If Tesco cut its dividend, when it would still have been covered by forecast earnings-per-share (EPS), what hope for Morrisons when its dividend will be uncovered by EPS?
Certainly, on the face of it, things dont look promising. Morrisons is expected to deliver EPS of about 11.8p this year, which doesnt support a repeat of last years dividend of 13p.
However, there are three big differences between Tesco and Morrisons that can give the latters shareholders cause for optimism.
In its annual results for the year ended 2 February 2014, announced in March, Morrisons made a commitment to 5% minimum increase in dividend for 2014/15 and a progressive and sustainable dividend thereafter the 2014/15 dividend being not less than 13.65p.
Management was perfectly aware of the tough trading environment for the supermarkets, even going so far as to suggest that the success of the discounters, such as Aldi and Lidl, is structural, rather than cyclical.
There was no need for Morrisons board to make such a bullish commitment on the dividend, yet it did.
Free cash flow
Forget EPS, its cash that pays dividends. Morrisons set out a credible strategy for generating the free cash flow to deliver on its bold dividend commitment.
The company expects to generate 2bn of free cash flow in the three years to 2016/17. A 13.65p dividend this year would cost the company about 323m. Over three years, then, with modest annual increases the dividend would be covered a very healthy two times by free cash flow.
I said in the past that I thought the biggest threat to Tescos dividend would be the ousting of chief executive Philip Clarke, and the all-too-frequent kitchen-sinking that occurs when a new boss takes over a struggling company. That has, of course, now happened.
Morrisons chief exec, Dalton Philips, has also been under pressure. If his strategy shows signs of failing, we could see him, too, being manhandled into the ejector seat and an almost certain re-basing of the dividend to follow.
However, theres been no indication from the company that things arent on track, and recent market-share figures are positively encouraging.
A 7.9% yield
If Morrisons delivered that 13.65p dividend, wed be looking at a whopping yield of 7.9% at a current share price of 173p.
What should we be looking for in next weeks results that might confirm Morrisons as just about the biggest income bargain in the market?
Well, the board maintaining the interim payout at last years 3.84p would be something. But, if it increases the interim by the percentage it intends to increase the full-year dividend (meaning an interim payout of about 4p), it would be something else altogether: a massive signal of managements confidence in delivering for shareholders.
There is, of course, a risk that Morrisons will renege on its dividend commitment, which has perhaps increased after the precedent set by Tesco. As such, theres a good argument for waiting to see what happens next week. If Morrisons lifts its interim dividend, the shares are likely to rise. Even if they were to shoot up 10%, though, wed still be looking at a prospective income of over 7%.
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G A Chester has no position in any shares mentioned. The Motley Fool owns shares in Tesco. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.