In recent articles, I’ve been running some tests to gauge business and financial quality to see if dividends seem built-to-last at some popular FTSE 100 companies.
Of the firms considered, Royal Bank of Scotland Group (LSE: RBS), Lloyds Banking Group (LSE: LLOY) and Barclays (LSE: BARC) scored the lowest, suggesting fragile forward payouts, and here’s why.
Dividend records
Lloyds Banking Group and Royal Bank of Scotland didn’t pay dividends for several years, although Lloyds restarted payments during 2014 and Royal Bank of Scotland expects to pay out in 2016. Barclays raised its dividend a meagre 8% over the last four years, but at least the firm kept up payments.
For their dividend records, I scored Royal Bank of Scotland 0/5, Lloyds Banking Group 1/5 and Barclays 2/5.
Dividend cover
Royal bank of Scotland expects its 2016 adjusted earnings to cover its dividend around 20 times, although the yield is low at around 0.4%. Barclays’ forward cover runs at around three times earnings and Lloyds at about twice earnings.
I scored Royal Bank of Scotland 5/5, and Lloyds and Barclays 4/5 for their dividend cover.
Cash generation
Dividend cover from earnings doesn’t help pay dividends if cash flow doesn’t support profits.
These three banking companies’ cash-generation records, as with most big banks, is a woolly indicator of business health compared with businesses in many other sectors. Accounting quirks tend to corrupt the cash-flow record with banks — such as how the banks classify their loans and investments, for example — which seems to bolster or lower cash-flow numbers artificially. Â
But cash flow appears so volatile that I scored the three low. Royal Bank of Scotland got 0/5, and Lloyds and Barclays both received 1/5.
Debt
Banks tend to carry large debts and that’s a big part of the reason their businesses can be so volatile, cyclical and vulnerable in times of macroeconomic downturn.
I didn’t take any chances with these three firms’ big borrowings, scoring all three of them 0/5.
Degree of cyclicality
We saw in the financial crisis of the last decade how cyclical the banks are. Fluctuating share prices, profits and valuations are the order of the day with big banks as macroeconomic gyrations keep bouncing the firms’ businesses around.
For their exposure to cyclical effects, I scored all three firms 1/5.
The final reckoning
The overall scores are low and follow similar patterns.
|
|
Royal Bank |
Lloyds |
Barclays |
|
Dividend record |
0 |
1 |
2 |
|
Dividend cover |
5 |
4 |
4 |
|
Cash generation |
0 |
1 |
1 |
|
Debt |
0 |
0 |
0 |
|
Degree of cyclicality |
1 |
1 |
1 |
|
Total score out of 25 |
6 |
7 |
8 |
These are the lowest scorers of the firms I looked at and I’d reject them as long-term dividend-led investments.
The biggest red flag for me is the high degree of cyclicality inherent in each firm’s business. I can’t see the point in gathering an income stream if fluctuating capital is going to produce a highly uncertain outcome on total investor returns over the long run.