As the returns on cash dwindle into nothingness, the income stream produced by some top FTSE 100 stocks looks more enticing than ever. A select few now yield more than 7% a year, over 700 times the return on NatWest’s notorious cash ISA, which pays just 0.01%.
But a high yield is also a classic danger sign, as it often follows a sharply falling share price. Dividends aren’t guaranteed, and if the company doesn’t generate the cash to cover it, they can be culled overnight. So are these two 7% yields too good to be true?
Royal Dutch Shell
Anglo-Dutch oil giant Royal Dutch Shell (LSE: RDSB) now yields 7.6%, the third highest on the FTSE 100, and now makes up £1 in every £7.50 paid out. Last year, it handed investors a whopping £9.37bn, although that was lower than the £10.72bn paid out in 2009 .
Famously, Shell hasn’t cut its dividend since the Second World War, but unless the oil price shows a meaningful recovery, that proud record will have to be sacrificed. Dividend cover is now a wafer thin 0.2, suggesting that future payouts will have to be funded from debt. The BG acquisition has already forced gearing up to 28.1%, more than double 12.7% one year ago. However, management continues to hold the line, maintaining the interim dividend steady at 47 cents at the end of July, despite a 72% drop in Q2 underlying earnings to $1bn. It recently reported earnings-per-share (EPS) of just $0.29, and that gap needs to be bridged somehow.
Shell has been cutting costs alongside every other oil major but this won’t be enough to fund the dividend on its own unless the oil price meaningfully recovers. Talk of an OPEC price freeze and slip in US inventories sparked a mini-recovery last week, but now crude has slipped to around $46 again. Shell generated just $4.8bn free cash from operating activities in Q2, while the dividend cost the group $4.5bn, with annual forecast capex of around $14.5bn. These sums look precarious and another year of low oil prices may finally sink the dividend.
Berkeley Group Holdings
Along with its fellow UK housebuilders, Berkeley Group Holdings (LSE: BGK) suffered a big hit after Brexit. It traded at 3,285p just before the vote and despite recovering from the post-referendum crash it remains 20% below that at 2,606p. This has helped drive the yield to a super-sized 7.4%.
The recent share price collapse is starting to like a great buying opportunity, with the group anticipating £2bn of pre-tax profit to 30 April 2018, based on solid forward sales. The dividend also looks relatively secure, with Berkeley looking to pay out £10 per share evenly over the next five years. EPS are forecast to rise 44% in the year to April 2017, with revenues rising strongly to £2.68bn.
Also, the housing market generally has held firm after Brexit, with surveys repeatedly showing only a slight dip in prices and transaction numbers, which can easily be blamed on the seasonal summer lull.
These are early days and we will have a clearer view when the Government triggers Article 50, possibly next spring. But trading at 9.55 times earnings and yielding such a juicy income stream, and with housing demand strong in an undersupplied market, the future remains bright.