Following on from a bumper year, income seekers will have taken note of the dire predictions for UK dividend rates in 2016. Capita's third-quarter Dividend Monitor revealed the underlying payout (ex specials) was up 5.9 per cent year on year to £25.8bn, but analysts are predicting that the prolonged slump in commodity pricing will inevitably constrict the ability of many large-caps to fund existing dividend rates through organic cash flows.
Heavily indebted commodity trading giant Glencore (GLEN) has already confirmed it is scrapping dividend payouts in 2016 in a bid to preserve cash, while troubled mining group Anglo American (AAL) has followed suit. Another top-tier constituent, Standard Chartered (STAN), has come under pressure due to its focus on emerging markets; their waning performance both causal and symptomatic of the cyclical decline in commodity prices. The bank duly canned its dividend, cut 15,000 jobs, and went cap-in-hand to the market for £3.3bn in capital.
A recent research update published by AJ Bell looked at cover ratios for FTSE 100 constituents. It showed that cover for the 10 constituents with the highest forecast yields ranged from 0.4 in the case of BHP Billiton (BLT) up to 1.5 for bank HSBC (HSBA). Average cover for the remaining eight constituents came in at just above 1, which is broadly adequate, although 'equal cover' can still look a little anaemic depending on capital requirements.
Estimated dividend cover on the highest-yielding stocks for 2016
"Portfolio-builders may be better off focusing on stocks that offer dividend yields of 3-4 per cent that have good cover and are capable of increasing their payouts over time, rather than those where there is a yield of 6-7 per cent or more where cover is thin," AJ Bell's investment director Russ Mould said.
He added that investors should ideally target stocks with earnings covering the dividend payout by a multiple of two and look back and see that as an "average over the past eight years and the following two".
"When it comes to the fattest yields from the FTSE 100 right now, cover is skinnier than ideal."
Mr Mould said both BP (BP.) and Royal Dutch Shell (RDSB) were only at one times cover although noted they could pay dividends from their own resources while they await a rally in oil. HSBC, Pearson (PSON) and Aberdeen (ADN) must "all be watched very carefully", Mr Mould added, while the ones which "on paper look to be at greatest risk" are BHP, Rio Tinto (RIO) and GlaxoSmithKline (GSK).
The portents for BHP are far from encouraging, particularly in light of potential costs linked to November's Samarco tailings dam disaster in Brazil.
Pay rates in the extractive industries are obviously looking more vulnerable, but it's worth noting that a third of the increase in third-quarter distributions - some £600m - was attributable to translation effects from US dollar strength. And widely reported comments from analysts at Deutsche Bank have added ballast to an earlier analysis from the IMF suggesting that sterling remains fundamentally overvalued. Some analysts now believe the pound could conceivably lose around a fifth of its value relative to the greenback, particularly if the US Federal Reserve continues to tighten its monetary policy, while the Bank of England sits on its hands - we shall see.
