If the general rule of thumb that yields above 7% are unsustainable is true, then HSBC (LSE: HSBA) and SSE (LSE: SSE) shareholders may need to start worrying.
The long share price descent and progressive dividend policy at HSBC means yields have now reached a whopping 7.9%. Cover for this high dividend has now fallen to 1.27 times earnings, down from 2.24 times just four years ago.
Although analysts are forecasting a 4% rise in earnings for 2016, I remain doubtful that the bank will hit this target. After all, analysts were forecasting a $1.95bn profit in the past quarter but were instead hit with a surprise $858m loss.
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Casting further doubt on rosy projections is the fact that turnaround plans for the bank are progressing much more slowly than anticipated. Although the $5.2bn sale of its Brazilian operations is still on track, no suitable buyer was found for the underperforming Turkish operations. Management has done an about face and is now planning to remain in the country and attempt to restructure operations.
Inability to deliver on restructuring efforts like this is why return on equity, a key performance metric for banks, slipped for the second consecutive year to 7.2%. This is well below the bank’s long term target of 10%, which remains several years away in even the best of scenarios.
If earnings continue to fall in the short term, HSBC will find it impossible to maintain progressive dividend payouts and keep already weak capital levels high enough to meet regulatory demands. With the turmoil in China, the bank’s key market, and glacial pace of restructuring, I have to believe falling profits leave the future of progressive dividends at HSBC very much in doubt.
High capex and troubled retail
Utility SSE has long prided itself on increasing dividend payouts by more than the pace of inflation year after year. However, with profits stagnating over the past two years cover for the 6.2% yielding dividend has weakened to a mere 1.25 times 2016 forecast earnings. This number is especially worrying as profits are expected to dip a full 9% next year and remain flat from then on.
SSE’s worries stem from several issues; falling prices crimping profits from its gas production business, high capital expenditure related to developing renewable energy sources, and a troubled retail business. While the first issue is cyclical and will work itself out, the other two are worrying for the sustainability of dividends.
Long-term viability of investing in renewables remains highly dependent on government subsidies. Even with these subsidies SSE’s return on capital has been flat for the past four years, suggesting that these investments haven’t panned out. The retail business is also in trouble as 540k customers left for other providers in the past year and the company was forced to announce a 5% reduction in prices in order to remain competitive.
These issues suggest that earnings will continue to fall, or at best remain flat, in the coming years. This will leave management with the option of cutting dividends to save cash, or turn to debt markets to fund shareholder returns. Neither is a great option for investors.
