For income investors, the FTSE 100 right now is beginning to look like chum in the water to a great white shark. While the overall index may be flat over the past year, yields are beginning to hit astronomical levels: 8.5% at Rio Tinto (LSE: RIO), 8.1% at Aberdeen Asset Management (LSE: AND), and 6.2% at SSE (LSE: SSE) are just some of the offers on tap. However, are investors right to take a bite out of any of these super yielders?
The downturn in China and commodity-dependent developing nations has led to massive outflows from Aberdeen Asset Management’s emerging market-centric funds. Since reaching a record high in April, share prices have tumbled 53% and sent dividend yields to an astounding 8.1%. Aberdeen’s dividend is now covered a mere 1.4 times by earnings after 11 quarters of net fund outflows have left the company with weakened cash-generating abilities.
While the dividend is covered for now and Aberdeen’s very healthy balance sheet leaves tapping debt markets as an option, I wouldn’t be jumping in to buy shares yet. Shares will likely continue to fall as emerging market sentiment worsens and Middle Eastern sovereign wealth funds, major customers of Aberdeen’s, continue to draw down their rainy day funds to fill oil-related holes in their budgets. Although the high yield is tempting, income investors should be looking for stability from their shares and I believe Aberdeen could be in for more turbulent times going forward.
More pain ahead?
Thursday’s trading update from SSE indicates management plans to continue progressively raising dividends at the struggling utility. A shrinking customer base and high infrastructure investment costs have damaged SSE’s balance sheet and this past year’s free cash flow wasn’t enough to cover dividend payouts. Furthermore, industry regulators are becoming increasingly agitated that decreased input costs from falling wholesale gas prices haven’t been passed on to customers.
Worryingly, today’s announcement of a 5.3% cut to customer’s gas bills was met with regulator Ofgem describing the need for even deeper price cuts. With customers fleeing to smaller competitors and price wars heating up, the outlook for SSE’s dividend doesn’t look bright to me. Although management may yet maintain dividend payouts by increasing debt or decreasing infrastructure investment, this will negatively affect the business over the long term and will drive down share prices for investors.
Million pound question
Whether or not Rio Tinto will be able to maintain its 8.5% yielding dividend payouts is the million pound question right now. While earnings for this year will just about cover the dividend payout, there’s little news on the horizon that would suggest free cash flow will be rebounding anytime soon. Although Rio has very low production costs for its major metal (iron ore), the global supply glut looks set to keep prices below levels at which Rio can afford debt payments, dividends and necessary capital expenditures at the same time. Rio is in better shape than most fellow miners, but will find continued dividend payouts difficult over the medium term if commodities prices remain in the doldrums.