Despite the gloomy forecast Capita says certain areas of the market have grown dividends and that underlying growth in mid-caps is hitting 16 per cent – although total UK dividends will stagnate at £25. 5bn in the third quarter, with pay-outs up just 0.2 per cent compared to the same period last year.Justin Cooper, chief executive of shareholder solutions at Capita, says the situation has gone from bad to worse throughout 2014.
“We always expected 2014 to be a year of slow growth for dividends, but it’s rapidly turning into a year of no growth. In real terms, underlying dividends paid are going to fall this year.”
“Just as firms have disappointed the stock market with weak earnings, so they have provided a poor showing for dividends too,” Cooper says.
He says the effect of a stronger sterling has hit corporate earnings this year as roughly 40 per cent of the UK’s dividends are declared in US dollars, while a lacklustre performance from the global economy also slowed dividend growth.
Larger cap firms at the top end of the index have been hit harder more than smaller ones with FTSE 100 dividends down 1.1 per cent in Q3 compared to a 7.6 per cent boost in the FTSE 250, reflecting larger firms gearing to global trends.
Smaller companies by comparison are typically benefiting from domestic exposure to a more robust UK economy, Capita says.
“Much of it is due to global factors which have overshadowed the strong recovery the UK economy is enjoying. FTSE 250 firms are winning the race as a result, with these domestically exposed firms boasting much stronger growth.”
“However, their dividend pool is too small for the big fish among investors, who need to retain significant exposure to the large cap firms which are doing less well at present,” Cooper said.
The pound has now begun to fall against the US dollar having hit a five-year high in July, though it remains strong against the euro.
Performance of sterling vs the dollar over 1yr
Source: FE Analytics
Capita says the current trend, if it persists, is low enough to provide a slight boost to dividends next year in Q2, which it estimates it will be between £800m to £1bn.
Cooper adds that he expects an improvement in the performance of larger caps deriving income in dollars although currency performance will remain a risk for further cuts.
“2015 should be much better. A lot hinges on the fortunes of the pound and on current trends there is some respite on the horizon.”
“Most important will be the performance of company earnings. Until those begin to flow through more strongly, it will be hard for dividends to make more rapid progress.”
Stephen Message, manager of the £135m Old Mutual UK Equity Income fund, is still optimistic that pockets of value remain for income investors, particularly in two sectors.
“The top 20 dividend payers to the UK market represent round two-thirds of the market’s income and so they are a big driver to the market yield,” Message said.
“As they are all dollar earning businesses the key thing to remember is that while Capita are not forecasting a lot of dividend growth this year, it is predominantly because of the top 20’s exposure to the dollar.”
He says that sterling’s strength has been quite a big headwind over the past year, particularly as sterling sold off ahead of the Scottish independence referendum.
“It less to do with the profitability of firms and more to do with exchange rates. If things stay as they are we will be saying the opposite and currency will become a tail wind.”
“You need to be a bit more stock specific. While at the market level it may be a struggle, you can still construct a portfolio that deliver an attractive rate of dividend growth in the right areas.”
Message says he expects to see the greatest dividend growth to come from financials.
He holds HSBC, Barclays and Lloyds in his portfolio having increased exposure over the past year on the expectation that dividends will increase in the case of HSBC and Barclays and that Lloyds looks set to pay its first dividend since the financial crisis over the next 12 months.
Telecommunication companies, particularly BT and TalkTalk, will also see stronger dividend growth relative to the market, Message says.
