Contributors to fool.com.au have written many times previously on the dangers of buying a company for its 'trailing' (i.e., last year's) dividend, which is usually the dividend published on retail brokerage websites.
For example, Metcash Limited (ASX: MTS) is recorded as paying a 6.2%, fully-franked dividend despite the fact that the company has suspended dividend repayments. Same too with Worleyparsons Limited (ASX: WOR) which is displayed as an 8.9% unfranked dividend, despite the likelihood that falling earnings will drag the dividend down.
However, sometimes these incredible trailing yields are the real deal. The dividends offered by the following companies are all very real, and brought about by heavy falls in those companies' share prices (which increases the dividend in % terms).
Readers could be forgiven for wondering if these yields are too good to be true. The answer is 'not always':
- G8 Education Limited (ASX: GEM) – yields 7.4%, fully franked
Investors have sold G8 in recent times over worries about its expansion strategy, including its tilt at Affinity Education Group Ltd (ASX: AFJ) and whether it will dilute shareholder earnings too far. Certainly the company's finances rely on high occupancy (above 90%) at its childcare centres, which appears to be sustainable thus far.
While debt is high the company has slowed the pace of acquisitions and appears well placed to continue to meet its obligations and pay dividends.
Assuming the company doesn't get too expansionist in the future, I do not see any difficulties for it in paying its current dividend. However, being G8 Education, the real question is whether it will be content to do that.
- Thorn Group Ltd (ASX: TGA) – yields 6.4%, fully franked and FlexiGroup Limited (ASX: FXL) – yields 7.9%, fully franked
Thorn Group and FlexiGroup have both been sold off on investor worries about our weakening economy and fears that increasing regulation around payments, maximum interest rates and so on will hurt profitability.
These are valid fears, but it is tough to imagine either company cutting its dividend in the foreseeable future as both have strong balance sheets and decent cash generation. Growth is another question, but for now both Flexi and Thorn's dividends appear to be quite sustainable.
- Origin Energy Ltd (ASX: ORG) – yields 8.2%, unfranked
Origin Energy's 8.2% dividend is definitely not sustainable as the company announced this morning that it was cutting dividends to 20 cents per share (down from 50 cents currently) for financial years 2016 and 2017 in order to improve its balance sheet.
That 20 cent dividend is paid from the profits of existing businesses (excluding its upcoming APLNG project) and appears reasonably sustainable, but reflects a yield of around 3% at today's prices, not 8%. While management stated the dividend may rise if commodity markets recover, this is not a certainty.
- Westpac Banking Corp (ASX: WBC) – yields 6.3%, fully franked
Westpac appears to have a robust dividend, although there is a question mark over whether further regulation, higher capital requirements and/or a deteriorating Australian economy will impact earnings in the future. The possibility of a collapse in the housing market would also hurt earnings and if a combination of these factors were to occur I think Westpac's dividends will fall.
The company is in a sound financial position at the moment, and its dividend appears quite sustainable. However, it is also worth noting that at this point in the economic cycle bad debts are very low and bank profits are very high, and a change in those metrics could see dividends come under threat. For that reason I am not yet buying Westpac for its dividend.
