Here are the six shares that have been through Evolution Securities' dividend stress testing screen. We have put our own views in regarding the sustainability of the dividend payouts where applicable.
Meggitt
Aerospace engineer Meggitt looks the most consistently secure dividend payer on Evolution's list, covered 2.5 times in 2009 and 2.2 times the following year. The company's largest division sells sophisticated components to plane-makers Boeing and Airbus, and it profited handsomely from an aerospace upswing that began in 2003, and culminated in a 45 per cent rise in commercial aerospace sales last year. But airlines are now under pressure, and are deferring or cancelling orders for new planes due to a lack of finance and a desperate need to cut capacity as passenger volumes fall. Meggitt increased its dividend by just 3 per cent last year, and with gearing at 81 per cent, we'd be wary of this one.
BAE Systems
Defence shares often get mistaken for defensive shares, but like any capital goods supplier they are in fact cyclical businesses. That said, war is often good for business, and continued conflict around the world and heavy spending on military hardware means that BAE is almost permanently in the 'up' phase of the cycle. That hasn't stopped its shares slumping to near 12-month lows lately, on fears that overstretched governments may choose to cut back on military expenditure. They now yield around 5 per cent, and analysts suggest that the likely level of cuts will have a relatively minimal impact on sales.
Carillion
Carillion sits in the support services sector, but the main service it provides is, in fact, construction. That may set alarm bells ringing, but in fact the kind of projects it works on are not the kind that have come unstuck as a result of the downturn, like housebuilding or commercial construction. It's focused on the infrastructure end of the market, and is responsible for looking after a large chunk of the UK rail and motorways, after buying Alfred McAlpine last year, and has a strong position in the UK schools and hospitals building programme. It's also reducing its dependence on its home market, where the threat of public spending cutbacks looms large as a result of the huge government debt and an imminent change of government. In particular, it's picking up major state-backed infrastructure projects in oil-rich Abu Dhabi, and the Middle East is expected to generate sales of £600m this year. A recent trading update confirmed that business is still booming.
Daily Mail General Trust
It might seem odd to have a newspaper publisher in this list, when peers like Trinity Mirror and Johnston Press have slashed their dividends. DMGT isn't immune to the challenges of the industry, such as online rivals eating away at its classified advertising, and a general recession-induced fall in advertising revenue. The effects have been especially hard-felt in its regional newspaper division, Northcliffe, which saw revenues plunge 23 per cent to £166m at the half year, and profits drop 85 per cent to £6m as classified and property advertising dried up. But decades of conservative family ownership, plus contributions from the more resilient business-focused subsidiary Euromoney, mean that there is headroom in its stress tested earnings to keep paying the dividend – cover in 2009 is 2.2 times and two times in 2010. Management believes that its key advertising markets have stabilised, and its cost-cutting efforts will save £150m, significantly higher than the £100m it was originally targeting. Net debt remains a sticking point, though, at £1.23bn – and the half year dividend was flat year-on-year.
AstraZeneca
Big pharma is one of the most reliable defensive sectors there is, home – as Mr Stewart points out – not so much to national champions, but multinational champions. And the FTSE has two of them, GSK and AstraZeneca. Both offer huge, stable cash flows and have nudged up their dividends year after year, but it was Astra that made the cut in Evolution's analysis. The company increased its last full-year dividend by 10 per cent, and even though it scaled back its sales and earnings outlook, there should be further increases to come. The company is pushing through a huge cost cutting programme which it hopes will save it $2.5bn (£1.8bn) a year, while emerging markets continue to offer strong growth prospects. Admittedly, the threat of competition from generic medicine suppliers still lingers over the long-term outlook, but for the time being we think defensive shares like this are the place to be.
International Power
Reporting its full year results, power generator International Power warned that weaker US and UK power prices could knock profits. But that caution could prove unfounded, because there's a heat wave in Texas. In a state where even the terraces of enormous football stadiums are fully air conditioned, that means higher power consumption and higher prices. IP is able to benefit because it had only forward sold 45 per cent of its US generating capacity – well below the 70 per cent it had contracted in the previous year – and analysts now expect a margin boost that's likely to remain in place for some time. Some of its debt is due for refinancing in 2010, but with steady cash flows that shouldn't be an issue.
Stress-tested dividend winners
| Company | Meggitt | BAE Systems | Carillion | DMGT | AstraZeneca | Intl Power |
|---|---|---|---|---|---|---|
| Price (p) | 154 | 330 | 252 | 279 | 2700 | 233 |
| PE 2009 (x) | 5.8 | 8.9 | 7.3 | 8.1 | 8.6 | 7.2 |
| PE 2010 (x) | 5.2 | 5 | 4.7 | 4.8 | 5.2 | 4.6 |
| Yield 2010 (%) | 5.7 | 5 | 5.8 | 5.2 | 5.1 | 5.2 |
| Cover 2009 (x) | 2.5 | 2.4 | 2.4 | 2.2 | 2.2 | 2.2 |
| Cover 2010 (x) | 2.2 | 2.1 | 2.1 | 2 | 2 | 2 |
Source: Evolution Securities
