Pearson (LSE: PSON) and BHP Billiton (LSE: BLT) look to be two of the FTSE 100’s most attractive dividend stocks. Both support dividend yields of more than 7% and based on historic figures, these payouts are covered at least once by earnings per share.
However, if a share’s dividend yield exceeds that of the wider market, it usually signals that investors aren’t wholly convinced that the payout is here to stay. The FTSE 100’s yield is 4.2%, so it would appear that the majority of traders and investors believe Pearson and BHP will be forced to cut their dividend payouts shortly.
And it looks as if the market could be right here.
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Short-term relief, long-term pain
Even though Pearson recently announced a drastic restructuring to eliminate 4,000 jobs (10% of the company’s workforce) in an attempt to safeguard the dividend, it would appear that this action is only a temporary fix. Indeed, the cuts were announced alongside yet another profit warning from the business. It was the fourth 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.
Pearson’s earnings have been falling since 2011 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 — that’s a drop of around 37% in six years. However, since 2011 Pearson’s dividend payout has increased by nearly a third. As a result, dividend cover has fallen from two times to one.
Unfortunately, now that Pearson is paying out almost all of its earnings to shareholders, it’s difficult to see how the company will find the cash to invest for growth. As we’ve seen over the past six years, Pearson’s 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 company’s dividend under even more pressure.
A cut coming this year?
It’s 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. BHP’s shares currently support a yield of 12% and while the company’s 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.
BHP’s management is stepping up its hunt for acquisitions or new projects. Cutting the group’s annual payout, which cost the miner $6.6bn in its last financial year, would give it more flexibility 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.
