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The 65% of UK equity income funds that could be hit by a Shell dividend cut

01 August 2016

Brokers warn that investors in Royal Dutch Shell should “brace themselves” for a dividend cut, so which IA UK Equity Income funds are in the firing line?

By Alex Paget,

News Editor, FE Trustnet

The chances of a dividend cut from Royal Dutch Shell have increased markedly following a 72 per cent fall in the company’s profits, according to ayondo markets.

Shell, which is the largest listed UK stock with a market cap of £160bn, has been plagued with issues of late thanks to a prolonged period of oil price weakness. However, Jordan Hiscott – chief trader at ayondo markets – warns that the outlook for the oil major has deteriorated rapidly after massively undershooting its Q2 profits.

Like many FTSE 100 stocks, concerns have risen about the outlook for Shell’s future dividend payments as cover has fallen to low levels following a number of high profile takeovers – and given its weighting within the index, any potential cuts would have widespread ramifications.

Hiscott warns, though, that a dividend cut from Shell is now a matter of when, not if.

“Shell’s huge miss on Q2 profit estimates, by over $1bn, is the largest I’ve seen in a while,” Hiscott said.

“The firm is clearly feeling the effects of the low oil price and hefty costs related to its arguably expensive takeover of British Gas, but what surprises me is that, with a loss of this magnitude, dividends are yet to be cut.”

“With this in mind, it seems highly likely that we’ll see a cut to the full-year dividend later down the line.”

According to FE data, shares in the company have performed well of late due a rebound in the oil price and because the company reports in euros – therefore receiving a boost from Brexit-induced sterling weakness.

Performance of stock versus index in 2016

 

Source: FE Analytics

However, the stock sold off by 4 per cent yesterday and is down so far today and – with added concern about a cut – the dividend yield has spiked to 6.82 per cent.

As mentioned earlier, any cut from Shell would create problems for swathes of investors given its sheer size. Indeed, FE Analytics shows that a very high proportion of IA UK Equity Income funds face a potentially bumpy ride.

According to our data, a hefty 65.8 per cent of funds within the sector count Shell as a top 10 holding. Those 53 funds account for £33bn worth of assets, therefore making up 55.72 per cent of the peer group’s total AUM.

What’s more, 25.9 per cent of the sector have more than 5 per cent of their portfolio weighted to the oil major.

The IA UK Equity Income funds with the highest weighting to Shell

 

Source: FE Analytics


Of course, there is no certainty Shell will cut its pay-out. Indeed, the board has been committed to maintaining the dividend.

Nevertheless, there are a number of IA UK Equity Income funds taking big bets on the stock – again highlighting the major challenge facing investors in the peer group in regard to current yield against future risks to their capital.

The table shows the 10 funds with the highest weighting to Shell. It also shows the proportion of their current yields that are generated by the company – which is calculated by multiplying the company’s dividend yield by the fund’s weighting to the stock, then dividing that figure by the fund’s current yield.

It must be noted that it isn’t an exact representation as we used each fund’s most recent factsheet but the company’s dividend yield as of yesterday. Nevertheless, it gives a very good indication of how much these fund’s rely on the stock for their income pay-outs.

At the top of the list with a 9.21 per cent allocation is the £2.25bn JOHCM UK Equity Income fund, which is managed by Clive Beagles and James Lowen.

The fund has a value bias, which has led it to be one of the highest dividend paying funds in the peer group over the longer term.

Indeed, investors who bought £10,000 worth of units in January 2005 would have since earned £6,664 in income – with the managers only having had to reduce their annual calendar distributions in one of the past 10 years.

JOHCM UK Equity Income’s dividend and yield history

 

 

Source: FE Analytics *Income figures based on a £10,000 investment in January 2005

It has also consistently yielded more than the sector average over the past 15 quarters. At the moment though, Shell accounts for 14.46 per cent of its current 4.29 per cent yield.


The managers’ focus on cheap unloved stocks has meant JOHCM UK Equity Income has struggled over recent years as growth, as a style, has significantly outperformed.

As such, the fund has underperformed in each of the last two calendar years and in well behind the index so far in 2016 – meaning it is bottom quartile on a three-year view.

Though JOHCM UK Equity Income has the highest allocation to Shell, it is Alan Clifford and Alan Custis’ Lazard Multicap UK Income fund that has the largest proportion of its yield derived from the stock.

Indeed, though the fund has 9.2 per cent weighted to Shell, some 16.92 per cent of its current yield is dependent on the oil major.

Lazard Multicap UK Income, which is also underperforming so far in 2016, is overweight the oil & gas sector in general with BP also featuring in its top 10.

Custis has been positive on oil stocks for a long period of time, despite the fall in the underlying oil price. For example, he told FE Trustnet in December that oil stocks were among his favourite for the year ahead.

“There’s no investment going into the space, there are natural decline rates that impact on oil and gas companies, which is anywhere between 2, 3, 4 or 5 per cent depending on who you listen to, so if we’ve got a market of 95 million barrels a day, we need to find 3 million barrels each year just to stand still per day and that’s a lot of barrels,” Custis said.

“We’ve seen US production coming off from the peak which was 9.6 million barrels in the summer and we’re now at 9.1 million barrels, so now we’re on that definite decline rate.”

“We’re coming into next year and we’ll see where we lie in terms of demand. The market’s been really robust this year as there has been exceptionally high demand, and we think supply now is almost inevitably going to drop as we go through to 2016.”

Other funds to have a high weighting to Shell (and a have high proportion of their yield dependent on the stock) include Schroder UK Alpha Income, Premier Income, Threadneedle UK Equity Alpha Income and Royal London UK Equity Income

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