Investors need to beware of dividend yield traps when looking at high-yielding shares. Although high yields are tempting to income investors, they could also be a sign of potential dividend cuts or that a share price that has further to fall.
HSBC Holdings
HSBC (LSE: HSBA) (NYSE: HSBC.US) announced further cost cuts last week, with the bank now targeting annual cost savings of as much as $5 billion by 2017. To achieve this, HSBC will need to cut its workforce by almost a fifth and shed at least a quarter of its risk-weighted assets.
The bank has said that it is looking to sell its businesses in Brazil and Turkey; but is its management being radical enough. HSBC still has many underperforming businesses as the bank is spread so thinly across too many countries. Yet yesterday, CEO Steven Gulliver said HSBC will not sell its Mexican business, despite its limited presence there.
Although HSBC’s dividend is likely to remain well covered in the medium term, profitability is likely to remain weaker than its peers. HSBC has lowered its return on equity (ROE) target from 12-15% to more than 10%.
Mr Gulliver now expects that the bank will only meet its ROE target by 2017. But, with much of the restructuring yet to come, profitability could get even worse. Although HSBC has a forward dividend yield of 5.4%, HSBC will likely continue to underperform domestically focused banks.
AstraZeneca
AstraZeneca (LSE: AZN) (NYSE: AZN.US) has a strong development pipeline of 119 projects, with between 8 and 10 projects expected to get regulatory approval by 2016.
Revenues and earnings are likely to remain subdued in the medium term, as new products are unlikely to offset the declining sales from blockbuster drugs. Crestor and Nexium, along with other legacy drugs that have already lost patent protection, should see their revenue decline accelerate as more generic alternatives become more available.
The company trades at a forward P/E of 15.2, with a prospective dividend yield of 4.4%. Dividend cover is expected to be 1.49x. Longer term, though, AstraZeneca’s earnings should bottom out as most of its pipeline of drugs are in the earlier stages of development.
Laura Ashley
Laura Ashley (LSE: ALY) pays a very attractive dividend yield of 6.6%, with expectations that the company will continue to pay a dividend of 2.0 pence per share. Excluding the special dividend paid in 2014, the company has paid 2.0 pence per share since 2012, even as the dividend was not fully covered by earnings. This has caused a run-down of its cash pile, which now stands at £27.8 million.
In 2014, total revenue rose 3.1% to £303.6 million, with adjusted pre-tax profit rising 18.7% to £22.9 million. The brand’s UK operations remain weak, and the company reduced its store count from 209 to 205. Licensing and international growth is performing more strongly, and should continue to be the main driver of growth in the medium term.
Looking forward, analysts expect earnings will recover significantly this year, after an already strong performance in 2014. Its shares trade at a forward P/E of 10.5, and its expected dividend cover is 1.5x. This should mean that the dividend is well covered, and there is potential for dividend increases in the longer term. Given its strong balance sheet and compelling earnings outlook, Laura Ashley is an attractive income stock.
