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Are BT and Sainsbury shares top buys for income?

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Recent interim results from J Sainsbury (LSE:SBRY) and BT Group (LSE:BT.A) met with contrasting responses from the market: the grocer’s shares were pushed up 6.9% on the day, while the telecom firm’s were sold off 8.9%.
Nevertheless, both stocks offer generous dividend yields right now. And both companies are targeting increasing shareholder returns in the future.
How well do Sainsbury and BT scrub up as top buys for income investors?

High initial yields

Let’s start with their dividend yields. Sainsbury declared an interim dividend of 3.9p and analysts are forecasting a total payout for the year of 12.1p. At a share price of 209p, the prospective yield is 5.8% — if the analysts’ consensus is on the mark.
BT’s interim dividend was 2.31p and analysts are reckoning on a total payout for the year of 7.77p. At a share price of 114p, the prospective yield is 6.8%.

Dividend policies

Sainsbury’s board is aiming to deliver “strong ordinary dividends” and is targeting future returns of surplus cash to shareholders through “higher dividends and/or share buybacks.” BT has a “progressive dividend policy”.
As such, both companies have starting yields above the market average. And  shareholders are offered the prospect of potential rising returns in future years.

Sainsbury’s policy in context

I say potential rising returns, because dividends are never guaranteed.
In Sainsbury’s capital allocation priorities, ordinary dividends rank behind capital expenditure to support the business and maintaining a solid investment-grade balance sheet. The additional returns of surplus cash rank further down the list still, behind selective investment opportunities, such as lease buy-ins.

BT’s policy in context

BT’s “progressive” dividend policy is actually to maintain or grow” (my emphasis) the dividend each year. When setting the payout, the board takes into consideration a number of factors. These include medium-term earnings expectations and levels of business reinvestment.

At the end of the day, for any company to maintain or grow its dividend, it must ultimately maintain or grow its profits.

It may be able to support the dividend by drawing on its borrowing facilities — if there’s a temporary dip in profits. But if profits are persistently lower, or decline over a sustained period, the dividend will almost certainly have to be rebased to a lower level or suspended altogether.

Sainsbury’s free cash flow

Free cash flow (FCF) is the amount of cash a company has left after all necessary costs and capital expenditure to sustain the business. FCF can be used for a number of things, including investment for growth, reducing debt, and paying dividends, so it’s an important consideration.
Sainsbury said in its recent results that it continues to expect average retail FCF of at least £500m a year over its three fiscal years to 2025. The current-year analysts’ dividend forecast equates to £284m. As such, the dividend would be comfortably covered by FCF.

BT’s free cash flow 

BT said in its results that it now expects current-year FCF to be at the lower end of its previous guidance range of £1.3bn-£1.5bn. The City’s anticipating no more than £1.3bn annual FCF through to 2025. Nevertheless, this covers the current-year analysts’ dividend forecast, which equates to £772m.

Challenging times

Like many businesses, Sainsbury and BT are facing high operating cost inflation from energy prices and so on. They’re having to perform a balancing act between keeping costs for their customers competitive, investing for the future, and delivering dividends for shareholders.
Sainsbury, in particular, is having to absorb costs to stay competitive with Tesco, which has advantages of greater scale, and Aldi and Lidl, with their discount, limited-assortment business models.
Meanwhile, BT is in a phase of particularly high investment for the future, with a massive fibre build programme in full swing.
Given the challenging macro and individual business backdrops, City analysts are currently forecasting little to no dividend growth from either company through to fiscal 2025 at least.

My verdict

Sainsbury and BT wouldn’t make it on to my list of top buys for income if I were looking to build a portfolio of 10 or 15 leading sector picks.

Their lack of dividend growth forecast for the next few years — especially with inflation running high — relegates them below companies where I see better scope for rising payouts.

Having said that, if I were looking to build a more extensive income portfolio, doubling-up in sectors to mitigate individual company risk, Sainsbury and BT would appeal to me as second-string choices.

I think their relatively high starting yields are attractive. And I see reasonable prospects of them maintaining their dividends.

The post Are BT and Sainsbury shares top buys for income? appeared first on The Motley Fool UK.

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The Motley Fool UK has recommended Sainsbury (J). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.