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I’m building a list of the best FTSE 100 dividend stocks to buy today. And the huge yields on these UK blue-chip shares have grabbed my attention.
However, I believe these cheap UK shares are classic value traps. Here is why I’m avoiding them this month.
Persimmon
Prospective dividend yield: 5.7%
The housing market is highly turbulent right now as interest rates rise. But I plan to hold my shares in homebuilder Persimmon (LSE:PSN) as the long-term outlook remains bright.
Having said that, I have no intention of buying more for dividend income. Recent share price weakness has turbocharged the company’s dividend yield. Yet there’s a chance that shareholder payouts for the next two years could fall short of forecasts as house prices slump.
Latest data from Halifax on Thursday showed average property values slumped by a larger-than-expected 4.6% in the year to August. This was the biggest fall for 14 years, and more pain is likely as the Bank of England acts to curb inflation. Rising unemployment is another big concern for the housebuilders.
Persimmon’s latest scary trading update showed total completions of 4,249 between January and June. Sales were down sharply from 6,652 a year earlier, which — along with sticky build cost inflation — caused operating profit margins to almost halve (to 14%).
Pre-tax profits fell 66% year on year. And worryingly for future dividends, cash on the balance sheet plummeted to £367m from £862m at the start of the year.
Persimmon has already shown it’s not afraid to slash dividends. Given how rapidly cash is dwindling, and the weak level of dividend cover through to 2025, investors seeking passive income could end up disappointed. Predicted payments are covered between 1.4 times and 1.5 times by estimated earnings for the next two years.
J Sainsbury
Prospective dividend yield: 4.9%
Food retailers like J Sainsbury (LSE:SBRY) are popular shares in troubled times like these. Like Tesco, the supermarket chain’s share price has risen strongly in 2023, reflecting the stable nature of grocery demand.
Yet profits (and thus dividends) are also in danger here. Like Persimmon, Sainsbury’s carries dividend cover well below the widely regarded safety benchmark of two times. For the next two financial years (to March 2024 and 2025) this sits at 1.7 times.
There’s also the retailer’s under-pressure balance sheet to consider. Its net-debt-to-EBITDA clocks in at an uncomfortably high three times. Meanwhile, the borrowing costs on its large £6.3bn net debt pile will continue to rise in line with interest rates.
Sainsbury’s has a loyal customer base, helped in large part by its well-loved Nectar loyalty card. However, the retailer is still having to keep slashing prices to stop losing business to the discounters. And the strain is mounting as the cost-of-living crisis rolls on.
As a long-term investor, I’m especially put off by this backcloth of intensifying competition. Just today, Aldi said it hopes to open 1,500 new stores in the UK, altering its previous target of 1,2000 shops by 2025.
I think Sainsbury’s could find it tough to grow earnings in the years ahead. So I’d much rather buy other FTSE 100 stocks with large dividend yields.
