Dividend payments in the UK have been boosted by £3.4bn following Brexit-induced sterling weakness, according to the latest Capita UK Dividend Monitor report, though it warns the underlying picture for income investors “remains weak”.
While the EU referendum has dominated the headlines over recent months, one of the major causes of uncertainty surrounding UK equities heading into the year was the poor outlook for future dividend payments.
Thanks largely to the widespread demand for income, UK companies have increased their pay-out ratios over recent years. However, due to macroeconomic headwinds and sector specific challenges, many UK stocks have delivered poor earnings growth which – in turn – meant levels of dividend cover across the FTSE 100 had fallen dramatically.
Dividend cover in the FTSE 100
Source: Canaccord Genuity Quest
While most of the bad news had been limited to natural resources stocks – which had been hit by falling commodity prices – many (such as FE Alpha Manager Neil Woodford) warned that dividend cuts would be far more widespread going forward due to poor underlying growth at a corporate level.
Last year, the authors of the Capita UK Dividend Monitor warned about this potential phenomenon.
“Income investors have had terrific dividend pay-outs in 2015 so far, shrugging off some high profile casualties like Tesco. But the outlook is gloomier. Profits are lower relative to dividends than at any time since 2009, and we have seen some of Britain’s biggest dividend payers announce drastic cuts for the year to come, with the prospect of more to follow,” Capita’s Justin Cooper said last year.
However, the impact of the EU referendum has meant a significant change in trend in Q2 2016 – especially as a result of in the huge fall in the value of sterling against all other major currencies.
Performance of sterling in US dollars in 2016
Source: FE Analytics
While many are concerned about how foreign investment will be affected by the Leave victory last month, Capita’s report suggests income investors have (and will continue) benefit from this change to the status quo given around two-fifths of the dividends paid by UK-listed companies are declared in dollars or euros.
“The Brexit vote has completely changed the picture for dividends this year and beyond,” the report stated.
“The dramatic devaluation of sterling that followed the Leave vote as investors fled the UK means dividends declared in euros and dollars will generate more in pounds in the immediate future.”
This dynamic, along with another swathe of special dividends within the FTSE 100, means that total dividend payments hit a record high last quarter and the Capita report expects that headline figure to grow over the short term.
“Most Q2 dividends had been paid before the UK’s referendum on membership of the EU. Its effect on the second quarter was therefore relatively limited. It will not be so from here on.”
“UK dividends in fact reached a new record in Q2, thanks mainly to an unexpected flurry of large special dividends. At £28.8bn, the headline pay-out was 7.6 per cent higher year on year and surpassed the previous quarterly record reached in Q1 2014, which saw Vodafone’s record payment on the sale of its stake in Verizon Wireless.”
Capita now expects underlying dividend pay-outs to be 0.5 per cent higher this year compared to 2015, having previously expected them to fall 1.7 per cent to £75bn because of the cuts from big multinationals.
It notes that could be revised even higher if the pound continues to weaken.
The report also stated that special dividends in the UK should be £2.5bn higher than it previously pencilled in, meaning that the group’s forecast for headline dividends is now £82.5bn from £78bn, an increase of 3.8 per cent compared to 2015.
This is appears to be very good news for funds in the IA UK Equity Income sector.
A previous FE Trustnet study highlighted that, despite all the doom and gloom surrounding UK dividends, only 15 per cent of UK equity income funds cut their pay-outs to investors. This meant that the average distribution in the peer group has increased in each of the past five calendar years.
IA UK Equity Income sector’s dividend history
Source: FE Analytics *figures based on a £10,000 investment in January 2011
The Capita UK Dividend Monitor suggests underlying dividend payments within the popular sector will therefore increase once again in 2016, with funds that are exposed to international facing large-cap stocks likely to be the biggest beneficiaries.
Funds with a high weighting to those types of FTSE 100 stocks (as well as having decent weightings to overseas companies) include CF Woodford Equity Income, Liontrust Macro Equity Income and Evenlode Income.
However, the Capita UK Dividend Monitor warns that the FTSE 250 (which has been a good hunting ground for income investors given higher levels of dividend cover) is now potentially at risk from cuts given it’s more domestic focus.
In an article later this week, FE Trustnet will take a closer look at the IA UK Equity Income funds with the highest weighting to mid-caps.
While currency weakness has made the immediate outlook for UK dividends far rosier than before, the report suggests that investors shouldn’t get carried away.
The report states, for example, how the vote is likely to have a negative impact of foreign investments and therefore the UK economy. It also points out a weaker pound has only delayed the likelihood of dividend cuts across the UK.
“Beneath the froth of special dividends, the underlying performance was less exciting. Dividends fell 2.7 per cent year on year to £25.2bn, in line with our pre-Brexit forecast,” the report said.
“This fall came despite a £960m exchange rate gain on dividends declared in dollars and euros as the pound weakened in the months running-up to the EU referendum. UK company profitability has been poor over the last couple of years as a variety of negative forces have hit industries as diverse as oil production and supermarket retailing.”
“Dividends have held up much better than profits, but that means dividend cover (the ratio of profits to dividends) has fallen to very low levels. Inevitably, dividend growth is difficult to sustain in those circumstances and this explains why the underlying picture is weak.”
