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Income majors 2018

The outlook for London’s largest and highest-paying dividend stocks
Income majors 2018

Why do investors like dividend-paying stocks? Why do companies choose to pay dividends in the first place? And what might impact corporates’ ability to return cash to shareholders in the long run?

Reasons vary. Some shareholders are drawn to the steady income theoretically offered by dividends – which are of particular benefit to those in retirement. All things being equal, equities can approximate fixed-income securities – but with the bonus of payments potentially increasing over time, rather than being tied to a fixed coupon. For others, dividends provide a useful indication of a business’s balance sheet strength, and signal whether bosses are positive about future earnings.

For a company, aside from inspiring confidence among investors, dividends can represent an efficient way to reduce an otherwise unnecessary cash pile – for lack of any near-term investment options.


No promise of continuity

But dividends are also inherently unpredictable. Their continuity depends not only on a company’s own financial health, but on various macroeconomic influences, and wider moves in markets and asset prices.

We’re now one decade on from the beginning of the global financial crisis. Much has changed in the ensuing years – not least the Bank of England’s (BoE) introduction of quantitative easing, and its reduction of UK interest rates to historic lows to stimulate investment and spending. More recently, the 2016 Brexit vote led the pound to devalue against other western currencies amid uncertainty about Britain’s economic future.

For UK dividend-payers, by and large these circumstances could be deemed beneficial. Indeed, low interest rates mean companies can borrow cheaply to accelerate growth, while also offering income at an attractive premium to bonds and cash. For advocates of this theory, it is perhaps good news that the BoE expects base rate to reach just 1.2 per cent by 2021 – a meagre uplift from today’s rate of 0.5 per cent, particularly against the US Federal Reserve’s current range of 1.75 to 2 per cent.

But rates are tightening, and with this backdrop in mind, we have adjusted the criteria for the 2018 Income Majors screen by raising our minimum dividend threshold. This year, we profile the 10 largest constituents of the FTSE 100 with dividend yields of 5 per cent or more.

UK income majors

TIDMNameIndustryPrice (p)Price change (one year %)Fwd PE (x)Fwd DY (%)Market Cap (£bn)
RDSARoyal Dutch Shell 'A' shares*Integrated oil & gas         2,60625.711.75.47                        220.7
RDSB*Royal Dutch Shell 'B' sharesIntegrated oil & gas         2,67927.512.15.32                        220.7
HSBAHSBCBanks            701-2.912.55.54                        140.7
BP.BPIntegrated oil & gas            58229.213.95.29                        116.2
BATSBritish American TobaccoTobacco         3,945-23.812.55.40                           89.7
GSKGlaxoSmithKlinePharmaceuticals         1,539-5.514.05.21                           76.5
RIORio TintoGeneral mining         3,99918.311.55.40                           72.0
VODVodafoneMobile telecoms            188-13.617.27.25                           49.7
LLOYLloyds BankingBanks               63-                           44.5
NG.National GridMutliutilities            856-                           28.8
IMBImperial BrandsTobacco         2,879-16.510.67.03                           27.4

Source: Bloomberg, prices accurate as of 4 Jul (ranking calculated 21 Jun)

*Royal Dutch Shell 'A' shares have a Dutch source for tax purposes and are subject to Dutch withholding tax.

Over the following pages, the IC’s specialist writers examine the drivers enabling and hampering these companies to maintain their yields. Given the breadth of the industries they span – including oil and gas, mining, tobacco, banking, pharmaceuticals and telecoms – one might view these organisations as a decent yardstick for UK plc’s income cases.

However, the FTSE 100 is arguably more susceptible to macroeconomic swings than other indices – if for no other reason than that some of its largest members are multinationals, generating a significant proportion of revenue, and declaring dividends in dollars. A falling pound flatters dollar earners, so it is little surprise that London’s premium index often rallies on sterling’s weakness.


FTSE 100: leading yields

The FTSE 100’s dividend yield of 4.1 per cent far surpasses those of other international blue-chip indices – with the caveat that each comprises a wide range of constituents.

But is this yield premium sustainable in the long term? The latest forecasts appear to suggest so. Future dividend estimates are underpinned in part by earnings predictions and, according to a survey of city analysts conducted by investment platform AJ Bell, profit estimates for 2018 rose from £217bn to £224bn in the second quarter. Oil giants and banks are key to this anticipated momentum, but miners should also make a strong contribution thanks to robust metal and coal prices.

In turn, dividend forecasts for 2018 stand at £88.8bn. If this proves accurate, this would represent an 8 per cent increase on 2017’s payments, and an all-time high for the FTSE 100. This upgrade was in part triggered by a weaker pound against the dollar, a move that boosted the dividend prospects for income majors Royal Dutch Shell (RDSA) and BP (BP.), and HSBC (HSBA), whose forecast dividends of £25bn this year would represent 29 per cent of the index’s total payout.


The sectors driving FTSE 100 profits and profit growth
Percentage of forecast FTSE 100 profitsPercentage of forecast FTSE 100 profit growth
Financials24%Oil & gas32%
Oil & gas17%Financials23%
Consumer staples13%Consumer staples11%
Consumer discretionary10%Consumer discretionary8%
Industrial goods & serviecs7%Mining6%
Healthcare7%Industrial goods & services3%
Real estate0%Real estate0%
Source: AJ Bell (Dividend Dashboard Q2 2018)


Soaring debt

Companies’ debt levels also influence the future viability of dividend payouts. Borrowing money to pay equity investors seems untenable in the long term. But with interest rates so low, UK public companies’ collective net debt (borrowings minus cash) has soared. For 440 listed companies, it reached £391bn for the 2017-18 financial year.

A decade of UK-listed company net debt

A decade ago, the credit crunch led companies to reduce their borrowings. But net debt started rising again in 2014-15 – at a time when various companies’ profits were failing to impress. As financial services provider Link Asset Services explains, “to the extent that profits are a proxy for cash flow, dividends could only be sustained by borrowing”. Over the three years to March 2018, UK plc paid out £263bn in dividends, but only made profits of £316bn.

This might sound concerning and call into question current bullish dividend estimates for the blue-chip index. But Link Asset Services says net debt levels may now have peaked, and interest costs are better covered by profits. And, according to The Share Centre, dividend cover for the UK’s top 100 listed companies rose from 0.7 to 1.9 times over the past year. Profits rose 181 per cent – buoyed by resource stocks including Shell and BHP Billiton (BLT), and the likes of HSBC and British American Tobacco (BATS) – while dividends rose just 11 per cent.


Who’s out?

Yet the top spots in the dividend ranking have proved fairly consistent. Only BT (BT.) and AstraZeneca (AZN) have dropped out of scope since last year’s feature. On a contrary take, BT’s forward yield of 7 per cent still makes it an income major, although a 23 per cent drop in the beleaguered telecoms group’s shares in the past year alone suggests the market expects a cut, as we suggested might ultimately happen a year ago. AstraZeneca, meanwhile, has slipped from the list since we raised the yield threshold from 4 to 5 per cent. 

Into the top 10 stride a resurgent Lloyds Banking (LLOY) and British American Tobacco, whose acquisition of US peer Reynolds has dramatically enhanced its earnings, and resulted in a shift to quarterly dividend payments.


Royal Dutch Shell: here be cash flows

HSBC: capital improving but income remains a challenge

BP: dollar-declared dividends

British American Tobacco: Reynolds deal boosts income case

GlaxoSmithKline: return to good health

Rio Tinto: income could take a backseat to growth

Vodafone: rising through the clouds

Lloyds:Lower risk suits capital returns

National Grid:Balancing returns and investment

Imperial Brands: all eyes on the next generation