A Closer Look at Tesco's Dividend Potential

LONDON -- Dividend income accounts for about two-thirds of total returns, or the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of Tesco (TSCO 1.37%) (TSCD.Y 3.23%) and assessing whether the company is an appetizing pick for income investors.

How does Tesco's dividend history stack up?

Source: Tesco company accounts.

Historically speaking, Tesco has an enviable track record of delivering annual dividend increases, with 2012's full-year payment representing the 28th consecutive year of payout expansion.

This record was put on hold last year amid wavering fortunes for the giant retailer, however. Difficulties across the British retail environment, falling domestic market share in the grocery space, property writedowns in the U.K. and Europe, and a costly exit from its toiling Fresh & Easy U.S. operation prompted the company to put the dividend on hold as earnings collapsed. The company saw pre-tax profit slump 51.5% in the year ending March 2013 to 2 billion pounds -- the first time profit had dipped for some two decades.

What are Tesco's dividends expected to do?

Source: Digital Look.

Tesco said in last year's release that it attempt to deliver dividend growth "broadly in line with underlying earnings, with a target cover of more than 2 times." And City analysts expect the dividend to tread tentatively higher in the medium term as a greater focus on the U.K., from which the supermarket generates some two-thirds of its profit, kicks into gear.

The supermarket's toiling performance has prompted a call to arms by the board -- domestic sales rose just 1.8% last year but fell 1% on a like-for-like basis -- and its "Build a Better Tesco" scheme started last year encompasses extensive store refurbishments, better pricing, product improvements, and an end to its multiyear strategy of rapidly expanding its selling space at home.

How does Tesco's dividend prospects rate against the competition?

Source: Digital Look.

Tesco currently deals on a P/E rating of 11.4 for 2014, making it an attractive dividend pick compared with the wider FTSE 100.

A scattering of companies skews the price rating of the food and drug retailers sector, however, so a comparison with listed rivals J Sainsbury and Wm Morrison provides a more accurate picture of how Tesco rates. The former boasts a prospective yield of 4.3% and deals on a forward earnings multiple of 12.3, with the latter expected to yield 4.4% and presently trading at 11.2. In this respect there is not a mammoth gap between the readings of the three companies, although both of Tesco's rivals offer larger yields.

Personally, I believe Tesco is a stock worthy of strong consideration, as I think it has both the financial clout and the know-how to overcome the troubles of the past year. The company is starting to seriously address the challenge laid down by its rivals in the U.K. retail space, and although its U.S. operations failed to ignite, it is planning to ramp up activity in Asia, where trade has remained promising. I think Tesco is an exciting turnaround story and expect rebounding profits to drag dividends higher in coming years.

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