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Getting under the skin of high dividends

Should these companies maintain their distributions to shareholders?
Getting under the skin of high dividends
  • Why special dividends can be a zero-sum game for investors
  • Remember that high yields often exist to compensate high risk

The stocks we examine this week have each paid in the last year what appear unsustainable dividends that aren’t supported by earnings. High dividends (and high yields) arise for a range of different reasons:  simple over-distribution, returning excessive capital or from unsustainable surges in key market segments. In two cases, much of the dividend was a special payment (typically a zero-sum game for investors) driven by step change which means they do not form core, reliable income. In the third case, the high yield reflects high risk.

Dunelm (DNLM)  The UK homewares retailer is bucking an otherwise weak retail trend with sales more than 20 per cent above pre-Covid levels. This is driven by market share gains (partly self-help and partly drop outs from the likes of Debenhams) and a very sharp increase in online sales. Dunelm is in focus here because it is paying out large dividends uncovered by earnings. This is not a reckless policy, but rather a removal of excess capital through special dividends which appear, for now,  capable of continuing. Sadly, as special dividends are a zero-sum game for investors, perhaps Dunelm should consider buy-backs instead. 

VPC Specialty Lending investments (VSL) This is a highly specialised investment trust focused on non-prime, and thus, riskier, corporate debt. Investing in floating rate debt, VSL should see widening margins as interest rates rise, but conversely the risk of default is also likely to increase. This is a far more complex vehicle than most in the investment trust space and, overall, feels perhaps too risky for all but the boldest private investor. It is notable that VSL has paid an uncovered 8p dividend in each of the last three years, but does appear capable of sustaining this due to high free cash, so the near 9 per cent yield is real, but the stock does carry a lot of capital risk. 

Ferrexpo (FXPO) is an iron-ore mining stock with an apparent yield over 20 per cent – too good to be true? Sadly, yes. The previous financial year benefited from hyper-normal market conditions with the price of steel rising four-fold, leading to bumper but non-repeatable profits. A new policy on dividends will see 30 per cent of free-cash flow paid out which could mean a still well-above-average yield of 6 per cent or more. However, income here will be volatile like the steel price that drives the group’s trading.

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