What is the outlook for UK dividends?

Chris Mayo, John Husselbee, Jason Hollands, Hugh Yarrow and Ben Peters share their thoughts.

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Aug 08, 2016

Chris Mayo, investment director at Wellian Investment Solutions:

The last year has seen a period of uncertainty for UK dividends, with falling profits making investors wary as to which companies could maintain their payouts. A number of solid dividend payers have already cut theirs and many see this as a signal for similar action by others.

When looking at dividends in the UK, there is a big concentration bias towards the high yielding mega-caps. But while the headline rate looks appealing, the quality of the income streams does not look as good, as the profits of many FTSE 100 companies are barely more than the dividends they pay.

The oil and gas industry and mining companies are particularly under the spotlight, with falling oil and commodity prices expected to have a knock-on effect. In an ideal world, earnings would more than cover the dividend but BHP Billiton has cover of just 0.4 times, BP 0.9 times and Shell 1 times. At the moment they all have enough cash to pay the dividend but one questions how long this will be sustainable for and how long it will be before the dividend is being paid from debt.

Considering the uncertainty in stockmarkets, dividends are unlikely to stay at their current level. Companies cut dividends as a precautionary measure, so investors should expect a reduced level of dividend income generally. That said, we would not be surprised if the number of special dividends rose over the next few years as the impact of zero or negative interest rates makes companies more likely to pursue shareholder friendly activities rather than holding excessive cash.

John Husselbee, head of multi-asset at Liontrust:

The Monetary Policy Committee’s decision to cut rates for the first time since 2009 to 25bps has done savers no favours, so investors will continue to seek out dividend paying stocks for both current income and future growth.

However, with concerns on dividend cover and reports that dividends are forecast to fall in the UK for the first time since 2010, the hunt for regular dividends is far from easy. While a weaker sterling may have boosted the income pot, dividends at companies such as Shell are living on borrowed time.

The dividend story is far from over but fund buyers are reviewing the concentration and polarisation within the fund sector. To limit risk, they are seeking diversification, with many managers seeking alternative sources of income in fixed interest, global equity and real estate, and investing down the market cap spectrum into mid- and smaller-cap companies.

Jason Hollands, managing director at Tilney Bestinvest:

It has been a challenging environment for dividends over the last year, with a number of large firms cutting payouts. Overall, the outlook for UK dividends remains very mixed. Those businesses that have already cut payouts will be reluctant to do so again: when a business slashes its dividend it typically rebases to a level where they can progressively grow it again, so to cut twice would signal distress.

Of course, the elephant in the room is the potential impact of Brexit on the UK economy, which will weigh on payouts at UK domestically-focused cyclical stocks. However, it is important to remember that much of the overall UK dividend pool is generated by international firms with large non-UK revenues. These firms’ profits and will be flattered by the weakness of sterling, which should help boost payouts.

Hugh Yarrow and Ben Peters, managers of the Evenlode Income fund:

The dividend outlook for the UK market is very mixed. Several large companies have announced reduced or cancelled dividends over the last year or so. These cuts have been focused on the energy, mining, food retail, banking and utilities sectors. A variety of factors have led to these cuts: industry difficulties, large capital investment requirements, poor cash generation and high debt levels.

The EU referendum result may also affect the UK market’s future dividend payments. UK domestic sectors such as banks, commercial property, construction, house builders and retailers may find it more difficult to sustain or grow dividends. On the other hand, UK listed multinationals will benefit from the weaker pound when their global cash flows are used to pay sterling dividends.

At an aggregate market level, UK dividends are likely to fall over the next year or two. However, many high quality, market-leading British businesses remain well placed to sustain and grow dividends over coming years.

Companies such as Sage, Compass, Spectris, Paypoint and RWS Holdings all have strong balance sheets and are “self-funding” – generating enough free cash flow to fund future investments in the business alongside current dividend payments. They also have good long-term growth potential, but as asset-light companies only need to invest a relatively small proportion of cash flow back into the business to generate this growth – leaving plenty of spare cash each year to provide progressive dividends.

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