Would Tesco PLC (LON:TSCO) Be Valuable To Income Investors?

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Could Tesco PLC (LON:TSCO) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A 2.5% yield is nothing to get excited about, but investors probably think the long payment history suggests Tesco has some staying power. The company also bought back stock equivalent to around 0.6% of market capitalisation this year. Some simple research can reduce the risk of buying Tesco for its dividend – read on to learn more.

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LSE:TSCO Historical Dividend Yield, June 11th 2019
LSE:TSCO Historical Dividend Yield, June 11th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. In the last year, Tesco paid out 42% of its profit as dividends. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 53% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Tesco has available to meet other needs. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.

Remember, you can always get a snapshot of Tesco’s latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Tesco has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was UK£0.12 in 2009, compared to UK£0.058 last year. The dividend has shrunk at around 7.3% a year during that period. Tesco’s dividend has been cut sharply at least once, so it hasn’t fallen by 7.3% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying Tesco for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Over the past five years, it looks as though Tesco’s EPS have declined at around 10% a year. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company’s dividend.

Conclusion

Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Tesco’s dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Earnings per share are down, and Tesco’s dividend has been cut at least once in the past, which is disappointing. In sum, we find it hard to get excited about Tesco from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 16 analysts we track are forecasting for the future.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.