logo

Looking beyond banks for income

Posted on May 12, 2008 by Richard Beddard
Filed Under Companies, Investing |

Bank yields look generous but might prove ephemeral. So what else is out there?

Readers are giving me a pasting for a blog I wrote saying banks aren’t cheap enough. And sure enough, if you look at them in terms of their dividends, instead of their earnings, some of the banks look very cheap.

At 11.9%, Bradford & Bingley (BB) tops my list of high yielders with good dividend histories, and Alliance and Leicester (AL - 10.7%), Lloyds TSB (LLOY - 8.3%) and Barclays (BARC - 7.5%) closely follow it.

Those are good returns, assuming investors get them.

But last year, profits barely covered the dividends declared by all four of the highest yielding banks. Barclays had the highest dividend cover of 1.6 times and Alliance & Leicester, the lowest (1.1 times).

That’s problematic for income investors because if banks can’t afford their dividends, they’ll cut them, and a lower dividend would undermine the rationale for owning the shares. What’s more, a company also devalues the per-share value of the dividend when it issues more shares, for example in a rights issue, without increasing the total dividend payout accordingly.

I don’t have any special insight into the future profitability of banks. But it’s easy to see what’s deterring income investors. With banks like RBS and HBOS cutting their dividends and announcing rights issues, they’re wondering which bank’s next.

There’s more speculation about Bradford & Bingley, Alliance & Leicester and Barclays than Lloyds, but these judgements are difficult because of the numerous and speculative threats to their profitability. For example:

  1. The extent of their losses in the US mortgage market
  2. Falling house prices, and the prospect of reduced mortgage lending
  3. The pressure on banks to use funds to rebuild their capital ratios instead of lending the funds out

In one way, HSBC (HSBA) stands out. Its latest earnings per share is a not-so-risky 1.8 times its dividend per share, and although it’s been criticised by an activist investor for lack of focus, diversification across international, retail, and investment banking has proved a source of strength while banks dependent on the troubled credit and housing markets are suffering, or indeed falling apart.

The problem is, in another way HSBC doesn’t stand out. From an income investor’s point of view, it’s a victim of its own success and yields a less enticing 5.2%. It’s high by HSBC’s historical standards, but not in relation to its peers.

So are there safer and more generous dividends out there?

The first names that stand out are newspaper groups; Trinity Mirror which yields 8.2% (covered 2.6 times) and Johnston Press, which yields 7.4% covered 4.2 times. Newspapers, though, are facing new competitive pressure from the Internet that makes their futures perhaps even more speculative than the banks’.

Here are some other prospects, with interest cover over 1.5 ranked by dividend yield:

Missing out on a place in my top 10, by only one place, is a bank: Allied Irish Banks (ALBK - 5.7%, 2.5X).

Expect me to take a look at some of these companies soon :-)

Category: Companies, Investing

Comments

Leave a Reply