The study, which looked at companies in the FTSE 100 and FTSE 250 indices, showed that the dividend cover ratio was just 1.4 times at the end of June 2013 – the lowest level it has been since the first quarter of 2010. At the same point of the year in 2011, the cover was at 2.3 times.
Dividend cover is a ratio defined by profit after tax divided by dividends paid. The higher the ratio, the more profits are available to pay out to shareholders in dividends and the less likely a downturn in profits will necessitate a cut in the dividend.
Both the large and mid cap markets have seen cover fall steeply from 2010 and 2011, which The Share Centre argues is as a result of "weak company profitability". Firms have been keen to appease investor-demand for income by maintaining a stable dividend policy, but this move caused cover to fall significantly.
While many experts argue that the economic recovery taking hold in the UK should drive profitability higher, research investment analyst Helal Miah (pictured) says cover is likely to remain low for at least the rest of the year.
He says certain sectors such as mining have seen a particularly dramatic fall in dividend cover, which should act as a warning signal to investors reliant on income. "Companies are under constant pressure from shareholders to sustain dividend flows, even under difficult economic conditions," he said.
"With fixed income investments yielding such paltry returns, equity investors have clamoured even louder for dividends. Company boards have acquiesced, allowing payouts to rise faster than profits over the last three years, leading to a sharp fall in dividend cover."
"The mining sector has abandoned traditionally strong dividend cover over the last year, as profits have plunged, raising questions about dividend sustainability from that sector."
"Coverage ratios have become uncomfortably low, but their profits have likely bottomed out, meaning better ongoing support for dividends."
Miah says investors must look at companies on a case-by-case basis as some of them have much better cover than others; however, he admits the cover cannot remain as low as it is now.
"Since many companies are cash-rich at present, owing to low capital investment, they can afford to keep distributions high despite lower earnings; however, dividends cannot continue to outstrip profits indefinitely," he said.
In a recent FE Trustnet article, Miah highlighted solid UK dividend-payers that are ideal for investors in retirement. These included some with very strong dividend cover such as Royal Dutch Shell, which has a ratio of 2.4.
This is the second time in 24 hours that experts have spoken of a specific threat to UK Equity Income investors. An FE Trustnet article published earlier today looked at how the slowdown in emerging markets is affecting a number of stocks that are popular with income managers, including Diageo and Unilever.
Charles Cade (pictured) of Numis Securities believes that slackening demand from the likes of China is likely to have had a knock-on effect on corporate profitability and thus dividend cover.
He points out that certain companies and sectors are in better shape than others, which should go some way in curing the concerns of investors reliant on income from yield-focused equity funds. Cade says holding an investment trust is an effective way of counteracting this risk, because unlike open-ended funds they have the ability to hold back part of their dividend every year, thus giving them cover of their own.
"Many companies during the financial crisis, and especially the banks, had to cut their dividends, and more recently BP had a big problem," he explained.
"Some UK equity income funds and trusts did struggle and had to cut their dividend, but more recently investment trusts have been upping their dividend cover – without a doubt."
"It’s definitely an advantage to be able to hold some of your dividend back and plan for the longer-term. Some trusts have been able to move out of the higher-yield area of the market and dip into other areas where they see more value, as they can rely on what they have saved up."
Cade points out that a number of equity income trusts have increased their dividend for many years in a row – sometimes decades at a time. According to the AIC, Job Curtis’ City of London IT has raised its dividend for 46 years in a row, while the Merchants Trust and Temple Bar IT have achieved the feat for 30 and 29 years, respectively.
