Are Dividends Built To Last At HSBC Holdings plc And National Grid plc?

How safe are HSBC Holdings plc’s (LON: HSBA) And National Grid plc’s (LON: NG) Dividends?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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: HSBC Holdings (LSE: HSBA) the international bank and National Grid (LSE: NG) the gas and electricity transmission system operator.

These firms operate in different sectors, but they both have a high dividend yield. At the recent share price of 605p, HSBC Holdings’ forward yield for 2015 is 5.9%. At 878p, National Grid’s is 5%.

Let’s 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 enjoy a decent dividend record:

Ordinary dividends

2010

2011

2012

2013

2014

HSBC Holdings

23.4p

26.65p

29.25p

31.85p

32.5p (e)

National Grid

38.49p

36.37p

39.28p

40.85p

42.03p

Over four years HSBC Holdings’ dividend advanced 39%, delivering a compound annual growth rate of 8.6%. National Grid’s moved forward by 9%, scoring a modest growth rate of 2.2%.  

For their dividend records, I’m scoring HSBC Holdings and National Grid both 2/5

  1. Dividend cover

HSBC Holdings expects its 2015 adjusted earnings to cover its dividend around 1.7 times. National Grid expects cover from earnings of about 1.3 times. My ‘ideal’ dividend payer would cover its cash distribution with earnings at least twice.

Of course, cash pays dividends, so it’s worth digging deeper into how well, or poorly, both companies cover their dividend payouts with free cash flow — that’s cash flow after maintenance capital expenditure.

On dividend cover from earnings, though, HSBC Holdings scores 3/5 and National Grid 2/5.

  1. Cash flow

Dividend cover from earnings means little if cash flow doesn’t support profits.

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

HSBC Holdings

2009

2010

2011

2012

2013

Operating profit ($m)

5,298

16,520

18,608

17,092

20,240

Net cash from operations ($m)

6,898

55,742

79,762

(9,156)

49,977

National Grid

         

Operating profit (£m)

3,293

3,745

3,539

3,749

3,735

Net cash from operations (£m)

4,516

4,858

4,228

3,750

4,019

As we might expect, National Grid’s toll-bridge style regulated monopoly distribution business delivers rock-solid cash flow that supports profits like granite.

Then we have HSBC Holdings. Cash flow at banks is a less useful indicator of business health than that at other types of business. Banks’ cash flow tends to be ‘noisy’, as we see here. Accounting quirks — such as how the banks classify their loans and investments, for example — can bolster or lower a cash-flow number artificially. It all adds to the opaque, black-box feel that surrounds banks, rendering them almost uninvestable, in my view. 

I’m scoring HSBC Holdings a benefit-of-the-doubt 3/5 for its cash-flow record and National Grid 5/5.

  1. Debt

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

Most banks carry big external debts and HSBC Holdings balance sheet entry for debt securities exceeds four times the level of its operating profit last year. However, bank debts come in many forms, so that’s not HSBC Holdings’ only exposure.

National Grid is also a big user of borrowed money, with debts running in excess of five times the level of operating profit.

Arguably, utilities and banks run particular types of business that require, and can justify, high debt loads. That said, they would make more secure investments with lower levels of borrowed money. I’m awarding both HSBC Holdings and National Grid 2/5.

  1. Degree of cyclicality

We saw in the financial crisis of last decade how cyclical the banks are. Fluctuating share prices and valuations are the order of the day with banks such as HSBC Holdings, as macro-economic gyrations keep cash flows, profits and asset valuations bouncing around.

National Grid is far less cyclical. Domestically, we keep using gas and electricity no matter what the economic weather throws at us, although industrial and commercial demand can wane during recessionary periods.

HSBC Holdings scores 1/5 and National Grid 4/5

Putting it all together

Here are the final scores for these firms:

 

HSBC Holdings

National Grid

Dividend record

2

2

Dividend cover

3

2

Cash flow

3

5

Debt

2

2

Degree of cyclicality

1

5

Total score out of 25

11

16

National Grid wins this face-off, but neither firm is perfect by these measures, so my search for a dividend champion continues.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

5 steps to start buying shares with under £500

Learn how this writer would start buying shares with a few hundred pounds in a handful of steps, if he…

Read more »

Young happy white woman loading groceries into the back of her car
Investing Articles

The FTSE 100 offers some great bargains. Is this one?

Our writer digs into one FTSE 100 share that has had a rough 2024 to date, ahead of its interim…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

£9,000 of savings? Here’s my 3-step approach to aim for £1,794 in passive income

Christopher Ruane walks through the practical steps he would take to try and turn £9,000 into a sizeable passive income…

Read more »

Group of young friends toasting each other with beers in a pub
Investing Articles

I’d buy 29,412 shares of this UK dividend stock for £150 a month in passive income

Insiders have been buying this dividend stock, which offers an 8.5% yield. Roland Head explains why he’d choose the shares…

Read more »

Red briefcase with the words Budget HM Treasury embossed in gold
Investing Articles

Could the new UK budget spell growth for these 6 FTSE stocks? I think so!

Mark David Hartley considers six UK stocks that could enjoy growth off the back of new measures announced in the…

Read more »

Investing Articles

With a 6.6% yield, is now the right time to add this income stock to my ISA?

Our writer’s looking to boost his Stocks and Shares ISA. With this in mind, he’s debating whether to buy a…

Read more »

Dividend Shares

This blue-chip FTSE stock just fell 12.5% in a day. Is it time to consider buying?

Smith & Nephew is a well-known, blue-chip FTSE stock with a decent dividend yield. And its share price just dropped…

Read more »

Investing Articles

At 72p, the Vodafone share price looks to be at least 33% undervalued to me

Our writer looks at a number of valuation measures to determine whether the Vodafone share price reflects the fair value…

Read more »