Digging deep for reliable UK dividends

Now BT has to contend with the additional threat of rising interest rates – concerning for a company that reported £11.2bn of net debt at the end of June this year – and yet it continues to stubbornly churn out dividends to shareholders. Scepticism that the income can be maintained has sent the yield up to more than 6 per cent.

BT is not alone in its dividend follies. According to analysis from investment platform AJ Bell, FTSE 100 dividends are only expected to be covered by earnings by an average of 1.74 times in 2018, while the average for the 10 biggest yielders is a measly 1.13 times. Earnings cover has fallen short of the two times annual payout 'comfort zone' in every year since 2014, which means there are a worrying number of large income stocks paying their dividends out of cash or debt.

And yet, total UK dividend payments are expected to increase to within touching distance of £100bn in 2018 – up 5 per cent on the prior year. According to data compiled by Link Asset Services, normal dividends (excluding specials) rose 6.9 per cent to £31.6bn in the third quarter, the highest quarterly payout ever. Throw in specials – including the remarkably generous £230m one-off paid by Quilter (QLT) following its June IPO – and the UK’s income investors pocketed £32.3bn in the three months to September 2018.

But these attractive statistics should be viewed with a hint of scepticism. UK dividends are unusually weighted towards just a handful of companies – BP (BP), Shell (RDSB) and HSBC (HSBA) alone contributed over a quarter of the total payout available in 2017 – so when BP raised its dividend by 2.5 per cent (its first annual rise since 2014) this year, it had a magnified impact on the total returns for the whole market.

Plus, with the exception of the mining sector – where many of the major companies have reinstated their dividends in the past few years – growth has been depressingly flat. Overall returns have been boosted by one-off hikes in the banking and travel sectors and by the weakening of the pound against the dollar (which is the reporting currency for a large portion of the big dividend-payers).

Optimists should also take heed of the UK’s most indebted sector: consumer staples. These historically defensive, reliable income payers have used their impressive earnings visibility to borrow heavily at a time of remarkably low interest rates. British American Tobacco (BATS), for example, is currently sitting on £45.7bn of debt (or 73 per cent of its total equity), following its merger with US giant Reynolds. That’s all well and good during a time when debt can be serviced at very low costs, but interest rates are beginning to rise. True, 1.65 per cent can hardly be called an expensive borrowing rate, but a shift in macroeconomics still warrants caution, especially for investors who hold consumer staples for their reliable dividends.

Generous and reliable income: Top 10 FTSE 100 well-covered high-yielders