Investment Committee: Is the UK facing dividend cuts this year?



Laura Suter is editor of Fund Strategy

Last year began a period of uncertainty for UK dividends, with falling profits making investors unsure which companies could maintain their payouts. Tesco cut its dividend, which many saw as the signal for similar action by other solid dividend payers.

The oil and gas industry and mining companies are particularly under the spotlight, with falling commodity prices expected to have a knock-on effect on these normally solid dividend payers.

More supermarkets are likely to be under fire as the price war militates against profits, while there are also rumours of dividend cuts among pharmaceutical giants such as GlaxoSmithKline and AstraZeneca.

Research by AJ Bell into the dividend cover of FTSE 100 companies does not make pretty reading. In an ideal world, earnings would cover the dividend twice over, but resources firm BHP Billiton has cover of just 0.4 times, BP has 0.9 times and oil giant Shell 1 times.

Sir Philip Hampton, chairman of GlaxoSmithKline, which has 1 times cover, was reported as saying he sees the company’s 6 per cent dividend yield as a “financial straightjacket on the business”. After such comments it would not be a surprise if the GSK dividend was reduced. So where can the UK equity income investors who crowd into many of these companies go to get their payouts?

Some experts suggest a move down the market cap scale, from FTSE 100 stocks into the FTSE 250 and FTSE 350, where stocks are better able to increase their dividends, albeit sometimes from a smaller base.

Jonathan Davis

Jonathan Davis is managing director of Jonathan Davis Wealth Management

I’ve been bearish on equities for a long while now and I continue to be so. The macro picture is dire, with slowing global growth, falling global debt levels, falling manufacturing and China exporting deflation, to name a few. In this environment, both small and large international companies simply can’t make the profits they once enjoyed.

On top of this, we are seeing slowing UK growth. Indeed, 2016/17 could well be recessionary.

If dividends stay high it will be about the first time in history they have done so in a profits and economic recession.

Investors for income should expect reduced dividend income generally.  If, for example, the FTSE falls further and dividends stay the index could be paying over 6% per cent.  This is unlikely to sustain or even occur in a zero interest rate environment.

We see further falls in global equity indices this year and further sizeable rises in quality government bond prices.  That circa 3 per cent on long-dated US Treasuries is looking increasingly lip-smackingly attractive, as I type (mid January 2016).


James Calder is head of research at City Asset Management

In my view, the outlook for UK dividend stocks has deteriorated and will continue to do so throughout 2016. This view emerged towards the end of last year and led to some changes within our asset allocation that were implemented in the latter part of 2015.

While our overall weight to the UK did not change, the structure did. UK Equity income was reduced in favour of UK long-short funds. The question we have to ask is: why is there all the negativity on UK dividends? We undertook some very simple research and realised that the percentage of the market that provides the overall yield is very concentrated; the top ten stocks contribute 43 per cent of the market yield and commodity stocks play an important role.

Despite their recent falls, commodity related stocks still account for a large proportion of the index. Moreover, a number of income or dividend stalwart stocks are under severe pressure with regards to dividend cover, due to a deteriorating outlook.

As a consequence, our view towards this group of stocks has dimmed over recent months and we have reduced our exposure to UK equity income and will likely continue to do so over the coming months.


Peter Lowman is CIO of Investment Quorum

We have seen the FTSE 100 fall from an all-time high of 7,104 in April 2015 to around 20 per cent lower this year. Alongside this fall has come forecasts that many of our leading companies will soon be cutting their dividends, if they haven’t already.

Clearly, this dilemma has affected many oil groups, miners and retailers that have struggled against a backdrop of much lower oil and commodity prices and tougher competition on the high street. Understandably, if global economic growth is slowing and with parts of the world even moving into a recession, then balance sheet weakness is going to be the likely outcome. Hence the possibility of dividend cuts.

This all sounds rather gloomy, and of course, there could be further implications for the UK market, and more importantly for UK income funds.

While we might see some dividend cuts from certain stocks that are vulnerable to current market conditions, there are many companies, such as some of the UK banks, consumer stocks and housebuilders that might increase dividend payouts as they benefit from the weaker pound and a strong demand from the likes of the property market.

For income seeking investors it will be very important to identify those UK Income funds with fund managers that are building their portfolio around the strengths and not weaknesses of the current investment and economic cycle.


Mike Deverell is investment manager at Equilibrium Asset Management

Dividend cover is a big focus for us when reviewing funds right now.

We calculate that, as a whole, the earnings of the companies that make up the UK market are about 1.7 times the dividends of the market. Dividend cover was almost three times five years ago.

If we look at the top 100 stocks this drops to just over one time, meaning the profits made by FTSE 100 companies are barely more than the dividends they are paying.

The picture gets worse when we look at some of the largest companies. Of the top 10 stocks, four have dividend cover of less than one, meaning dividends are not fully covered by profits.

This includes the oil giants but also some surprising stocks such as Vodafone and GlaxoSmithKline. While in the short term dividends can be paid from reserves, unless profits grow strongly these dividends could be cut.

This is one reason we hold a lot less in index tracking funds in the UK than we do normally. We much prefer actively managed funds that can avoid some of these potential pitfalls. In particular, we like funds that can go down the market cap scale and find potential bargains in smaller companies.


Tim Cockerill is investment director at Rowan Dartington

The concentration of the major part of the FTSE All Share dividend in the hands of a small number of companies has for a long time been a concern for investors and managers alike. It’s certainly true that if you invest without straying too far from the benchmark then dividend cuts from the big payers is a problem and with the oil price at $30 per barrel both big and small oil companies are going to really struggle to maintain payouts.

Indeed some oil companies have cut their dividend to zero. With Shell recently stating that profits will be half what they have been previously this puts enormous pressure on the management team. Many of their shareholders want them to maintain the dividend, but if the profits aren’t there then it might simply not be possible and a cut would seem both likely and prudent.

Big UK equity income funds tend to have a bias towards large cap dividend payers and it is these funds which seem most likely to be impacted by dividend cuts – although tobacco stocks look robust and these are a favourite with large income funds. While the UK market offers a lot of shares paying good dividends many are mid-cap or small-cap and fund managers are limited as to how much they can hold, so if you manage a pretty sizable fund then you can find yourself forced into the large caps.

I’m anticipating quite a lot of dividend cuts this year, but I expect some income funds to escape relatively undamaged because they have a focus on mid and small caps and aren’t themselves too large. Global equity income funds should also be better placed as their universe is that much wider, but any fund exposed to vulnerable sectors such as oil and gas must be at risk of cutting their dividend.


John Husselbee is head of multi-asset at Liontrust Asset Management

Finding investment income is not getting any easier. The Monetary Policy Committee decided again at their January meeting to leave interest rates unchanged, which means they have been at 0.5 per cent since March 2009, and means there is no relief in UK gilt yields anytime soon.

Meanwhile, many investors looking for income continue to turn their attention to dividend paying stocks for both current income and future growth. It remains a popular sector, according to Investment Association data the UK Equity Income Sector was the best selling sector seven out of the past 12 months. However there are now concerns on dividend cover and reports that dividends are forecast to fall in the UK for the first time since 2010. The collapse in the oil price is dragging down payouts although on the other hand a weaker sterling has boosted the income pot.

The dividend story is far from over, although fund buyers are reviewing the concentration and polarisation within the fund sector. They are seeking diversification, while many fund managers have been and continue to seek alternative sources of income, namely in fixed interest, global equity, real estate and investing down the market capitalisation in mid and smaller-cap companies.


Independent view:

Will Meadon is fund manager of the JPMorgan Claverhouse Investment Trust

UK dividends are on average going to be lower in aggregate in 2016. This presents a problem for investors who rely on the UK market for a regular and growing income.

On the surface, this fear might appear unfounded. For example, both the oil and mining sectors would appear to offer attractive dividend yields: BP offers a prospective yield of 7.7 per cent, Shell 8 per cent, while BHP Billiton’s yield of over 11 per cent is surely irresistible?

Regrettably, the market is not so inefficient as to offer investors such mouth-watering yields without them also coming with a huge health warning. Such high yields pose substantial investment risk to the unwary investor, as they may indicate unsustainable dividends over the medium-term.

For example, the balance sheets of all three companies mentioned above have suffered in 2015 from plummeting commodity prices. Even if they pay their dividends in 2016, each will have to borrow the money to do so, as they are not generating sufficient cash.

Investors should instead focus on stocks with lower yields but which have a greater certainty of dividends being paid or – better still – increasing.

Sectors with strongly supported dividends include housebuilders. Due to the shortage of houses in the UK, many quoted housebuilders have such strong order books and balance sheets that they have committed to minimum cash returns for the next few years. Barratt and Berkeley Group are two such companies and both yield over 4.5 per cent if they stick to their commitments for cash returns.

Other attractive sources of dividends include British American Tobacco and Imperial Tobacco, both of which yield over 4 per cent on a 12-month view with the latter committing to increase its dividend by 10 per cent per annum for the foreseeable future.