Written by Emma Cusworth investigates.
Dividends have always been a barometer for company strength. So should investors be worried about the ongoing trend for cutting shareholder payouts?
Dividends form a hugely important part of investors’ long-term returns from equity investing. In the UK, they account for the vast bulk of shareholder returns, research suggests. For long-term investors the trend towards dividend cuts by UK companies should therefore prove worrying, especially in light of growing dividends globally.
Traditionally, dividends are seen as far less volatile than stock prices because companies have proven reluctant to cut, preferring instead to absorb pressure on their profit and loss accounts. Dividend cuts have traditionally been seen as a very public sign a company is in trouble.
However, what goes up, must eventually come down – even in the world of dividends – and investors need to prepare themselves for the consequences of falling dividends in the long term. The irrefutability of Isaac Newton’s predictive prowess has played out in the headlines over recent months as British companies have made sweeping cuts to payouts. Rio Tinto ditched its long-standing promise not to cut its dividend, Rolls-Royce chopped its dividend in half in the first cut to dividends in a quarter century, while Barclays and Centrica have also cut pay-outs.
UK CUTS DEEP
According to data from Henderson Global Investors, UK dividends fell 5% on a headline basis in the first quarter of this year and the asset management firm warned of more cuts to come later in the year. In stark contrast, global dividends rose 2.2% on the same basis and are expected to rise 3.9% to $1.18trn this year.
Chris Reid, fund manager of the Majedie UK Income fund, also sees more cuts for UK investors. “We are expecting to see further high profile dividend cuts,” he says, adding they will fall into two categories. “Firstly, there are companies which effectively put their dividends at risk years ago, by milking their existing businesses for too long and using debt to overpay investors. The dividend cuts merely confirm that these companies have been backed into a corner; as
investments they should generally still be avoided. Secondly, there are companies where a dividend cut can provide a breather to gather their strength and to change course; the core businesses importantly remain unimpaired and these dividend cuts reflect decisive and positive management action, with the companies often emerging stronger for the experience. Aviva is a good example, having cut its dividend a few years ago but now, as a much healthier business, growing it again fairly aggressively.”
TOO MUCH CONCENTRATION
The relatively deep cuts in UK dividends, however, have also stemmed from the concentration of resources stocks listed here. UK equity investors are heavily reliant on oil, banks and mining companies, which account for almost half of the country’s equity income. The top 10 UK stocks, which include the likes of BHP Billiton, Rio Tinto, Shell and BP, make up 54% of FTSE 100 dividends.
“The UK has become the market of choice for mining companies to list,” says Ben Lofthouse, an equity fund manager at Henderson. “Once a market develops a specialism, companies go where they are best understood and there are other comparables,” he says, as those markets can prove more accommodating in terms of liquidity and the ability to raise capital.
The result of the overweight position in commodity-based companies is a natural correlation to the commodities super-cycle.
The dramatic fall in the oil price since the start of last year has wreaked havoc on UK dividends as a result.
“During the first quarter, the overarching theme for dividends has been the weak commodity prices,” Lofthouse says, adding that the trend will continue to play out in the coming 12 to 18 months depending on where the oil price ends up.
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