Are Lloyds Banking Group plc and GVC Holdings plc the ultimate dividend plays?
Shares in online gaming group GVC Holdings (LSE: GVC) rose by 4% this morning, after GVC announced a EUR0.56 per share dividend payment for 2015. The group said that revenue rose by 10% last year.
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This payout gives GVC shares a yield of more than 8%. Yields this high are normally seen as being too good to last, but GVC has a track record of big payouts backed by free cash flow.
Will this continue following the group's recent £1.1bn acquisition of lossmaking bwin.party Digital Entertainment?
Double or quits?
The first thing to remember is that GVC's lenders require the firm to suspend dividend payments for 2016. This is to ensure that early repayment of some the debt used to buy bwin takes priority. Given that GVC's net debt was EUR193m on 17 April -- 7.8 times last year's profits -- I think this is wise.
The second point of interest is that bwin made a EUR42.3m loss in 2015. That's more than GVC's pre-tax profit of EUR25.5m. GVC's management believes it can revive bwin's flagging brands and return them to growth and profitability. Cost savings of EUR125m are expected.
The City seems to agree. Broker forecasts for 2016 suggest that GVC's after-tax profits will rise sharply this year. However, the impact of the new shares issued to bwin shareholders means that adjusted earnings per share are expected to fall from to EUR0.80 in 2015 to EUR0.37.
This leaves GVC looking pricey in the short term, on 18 times 2016 forecast earnings. However, the long-term opportunity may be more attractive.
This dividend may also be risky
Shareholders in Lloyds Banking Group (LSE: LLOY) should be able to expect their dividend payments to be safer than those of gaming group GVC Holdings.
Despite this, Lloyds' dividend payout isn't without risk. As the UK's largest mortgage lender, Lloyds is heavily exposed to the UK housing market. Some investors -- including Neil Woodford -- believe that Lloyds' losses from bad debt could rise fast if house prices do start to fall.
There's no way of knowing how or when this might happen. In the meantime, UK banks such as Lloyds are gaining strength by building up their surplus capital and cutting costs. Lloyds is quite advanced in this respect. The bank's Common Equity Tier 1 Ratio (CET1) is 13%, higher than most of the other big UK banks.
Lloyds' costs appear very competitive, too. The bank's cost-to-income ratio was 49.3% in 2015. In contrast, Barclays is still hoping to reduce its costs to less than 60% of its income.
A bigger concern for Lloyds' shareholders might be the risk that the bank's dividend is growing too fast to be sustainable. The latest consensus forecasts suggest that Lloyds' dividend payout will be 56% of earnings in 2016 and 66% of earnings in 2017. It's easy to see how any shortfall in profits could force Lloyds to scale back its dividend targets.
The good news is that these risks seem to be reflected in Lloyds' valuation. The bank's shares currently have a forecast P/E of about 9 and a prospective yield of 6.3%, rising to 7.5% for 2017. In my view, investors hoping for a yield of at least 5% shouldn't be disappointed -- and could be pleasantly surprised.
However, if a reliable income is your top priority I'm not sure I'd choose Lloyds or GVC.
The Motley Fool's income experts are also cautious about these two stocks. Neither was chosen for the Fool's exclusive new dividend wealth report, 5 Shares To Retire On.
The Fool's top stock pickers steered away from banks and opted for stocks including a pharmaceutical giant, a utility and a drinks firm.
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Roland Head owns shares of Barclays. The Motley Fool UK has recommended GVC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
