Whatever problems the UK (and to be fair the wider world too) is grappling with, in the last quarter income investors led a charmed life. Figures from Link Group’s UK Dividend Monitor Report shows headline payouts rose 14.5 per cent to a record £37.8bn during the three months to June 2019. Despite the cash bonanza Michael Kempe, chief operating officer at Link Market Services, thinks “the UK’s dividend clothes are starting to look a bit threadbare”.
Special dividends from miner Rio Tinto (RIO), software firm Micro Focus International (MCRO) and Royal Bank of Scotland (RBS) contributed most to the headline increase, although the rise in underlying (ordinary) dividends was, at 5 per cent, weaker than expected. Alongside the notable specials, sterling’s weakness has done much to flatter headline figures, with exchange rate gains accounting for half the growth in underlying dividends.
Banks continued their resurgence as a leading income sector. Along with RBS and Standard Chartered (STAN) giving chunky payouts, Barclays (BARC) paid its largest post-crisis dividend. Fund managers like Stephen Message, who heads L&G UK Equity Income (GB00B6HBD759), are showing faith in the banks, stating: “We are attracted to the dividend recovery potential in the banking sector following several years of balance sheet repair.”
This is a view echoed by James Balfour of Aviva Investors UK Equity Income strategies. He also points out, thanks to the oversight banks are subject to since the 2008 crash, dividends could be robust: “These returns have only been allowed by regulators as they are happy with the capital position in a number of risk environments. Therefore, a slowing of macro conditions would not [cause] shock dividend reductions.”
For now, Mr Balfour also believes dividends from oil and mining are solid: “These sectors are clearly cyclically exposed but the funding of their base payments looks sustainable in anything but a very significant downturn in the global environment.” This is a view supported by financial data crunched into the Societe Generale (SG) Cross Asset Research team’s stock screens at the start of July. Their quality income screen uses Merton’s distance-to-default measure (a tool for estimating the likelihood of defaulting on debt) and the Piotroski quality checklist (which looks at profit, cash flow and various accounting solvency ratios) to avoid value traps. Against these criteria, Rio Tinto scored highly.
Stock screens are just part of the evaluation process and since SG last ran its, Rio has updated the market. There was good news for expected cash flows (thanks to strong iron ore prices), but the delay of the Oyu Tolgoi copper mining project in Mongolia highlights operational risks.
Elsewhere, idiosyncratic challenges have placed distributions in immediate jeopardy. Early indicators are that energy company Centrica (CNA) will slash dividends when it reports earnings on 30 July. Traditionally, utilities are considered defensive stocks with a safe payout, but these are businesses with sizeable debt, regulatory pressures and enormous capital expenditure requirements. Energy providers especially are in a state of upheaval. Reporting on the industry, analysts at Morgan Stanley questioned Centrica’s asset quality and its readiness in the face of a consumer-led revolution demanding green energy.
Highly anticipated disappointment from Centrica comes on the back of Vodafone (VOD) cutting its unsustainable dividend, and even tobacco giant Imperial Brands (IMB) has reduced the growth rate of payments it makes to shareholders. Going forward, Mr Balfour suggests structural issues could affect more companies’ ability to maintain dividends. For instance, telecom provider BT (BT.A) must commit high capital expenditure to roll out high-speed fibre-optic broadband across the UK.
Faced with significant restructuring costs, as it splits its healthcare and pharma businesses, GlaxoSmithKline (GSK) might rebase its payout. Both GSK and AstraZeneca (AZN) report this week and ahead of these results, Mr Message identified pharma as a sector his fund is underweight “given our concerns on the sustainability of current dividends in the longer term.”
Big pharma’s dollar earnings and the translational boost to dividends may still hold attraction, especially as Boris Johnson’s confirmation as UK Prime Minister will ostensibly increase the likelihood of a no-deal Brexit. It would be naïve to expect the pound to continue to fall and act as a continuous fillip for UK-listed overseas earners, though. Currency markets are a two-way bet and the likelihood of slower growth and looser monetary policy means tailwinds for the US dollar and euro are reduced.
