Income investors run for cover as dependable UK dividends in jeopardy
The sectors currently delivering the biggest dividends -- those that have kept yield-hungry investors in the UK market -- are showing signs of strain.
Oil and gas, pharmaceutical and consumer stocks account for nearly half of the UK market's total dividend payouts, Societe Generale data shows.
But factors from industry regulation to currency exchange are feeding concerns these dividends may erode, and causing investors to seek diversification into sectors where payouts may grow.
One headwind is currency.
Many of Britain’s major international exporting companies pay dividends in other currencies, so a weaker sterling has flattered income for UK investors and meant payouts increased even when companies kept dividends flat in dollar terms.
This helped the total dividend payout balloon to 33.3 billion pounds this quarter, up 14.5 percent from the same period last year, according to Capita Asset Services data.
But base effects from a weaker sterling will begin to disappear next quarter, with the pound strengthening and the dollar now on the back foot, down 9 percent year-to-date, raising doubts as to how long the currency windfall can be relied upon.
Other headwinds materialised when regulatory pressures and corporate events dented stocks in some of the sectors income investors rely on most.
Shares in British American Tobacco (>> British American Tobacco) and Imperial Brands (>> Imperial Brands), two of the most dependable dividend payers, plummeted after U.S. regulators proposed tighter rules on the amount of nicotine in cigarettes.
The sell-off caused investors to fret over tobacco stocks' ability to maintain steady payouts, though long-term investors in Marlboro maker Altria (>> Altria Group) stayed put.
"Investors are desperate for yield so they pay close attention to anything which could threaten their income stream," said Alex Dryden, global market strategist at JP Morgan Asset Management.
"We have been getting a few questions about the ability of these companies to continue to meet lofty dividend expectations," Dryden said.
Growing dividends show companies feel confident enough about earnings to hand more cash over to shareholders, but cracks are starting to appear.
High dividend yields, the ratio of dividend payouts to share price, are a tell-tale sign of concerns over some of the biggest contributors to income in the FTSE 100.
"If something yields more than 6 percent it's a red flag more than an opportunity," said Eric Moore, manager of the UK Equity Income fund at Miton Group.
"The market is pricing in the fact that these dividends will ultimately prove to be unsustainable."
Oil majors Royal Dutch Shell <RDSa.L> and BP (>> BP) are both on dividend yields of 7 percent -- well above the FTSE 100 average of 3.89 -- indicating concerns are being priced in.
Investors raised doubts about the viability of high dividend payouts from GSK (>> GlaxoSmithKline) and AstraZeneca (>> AstraZeneca) after disappointing results and a drug trial failure threw the respective companies’ dividend strategies into question.
Both firms have dividend yields above their sector average, and payouts are already eroding. The healthcare sector paid out 35 percent less in the second quarter this year than Q2 2016, data from Capita Asset Services showed.
Deutsche Bank analysts on Monday estimated GSK’s dividend outlook would be flat until 2022.
MINERS AND BANKS TURN ON THE TAPS AGAIN
So frustrated investors are turning to areas where dividends are likely to grow, like the mining and banking sectors. But these are vulnerable to the removal of the currency support.
“Dividends in the FTSE are a currency story, a Brexit story and a U.S. story,” said Kokou Agbo-Bloua, head of flows strategy at Societe Generale.
“People liked buying the FTSE 100 and dividends because the pound went down (after the vote to leave the European Union –- but now that the dollar is falling that trade is becoming less profitable.”
Miners are only just coming back into the dividend-paying fold, and yields for the likes of Rio Tinto and Glencore are at or below the index average, indicating investors are far less concerned than in 2015 when management was on the brink of slashing dividends as the sector entered a painful commodity downturn
Basic resource companies accounted for 1.1 billion of the total 2.6 billion pound year-on-year increase in FTSE 100 dividends in the second quarter, Capita Asset Services said.
This quarter every FTSE 100 mining company increased dividend payout, with sterling’s weakness a big boost to all of them.
Glencore (>> Glencore) returned to its dividend this year for the first time since 2015, and its current dividend yield of just under 2 percent signals investors predict it will increase.
Banks reviving from a multi-year downturn are also beginning to give money back to shareholders, with Lloyds (>> Lloyds Banking Group) increasing its payout last week, while HSBC (>> HSBC Holdings) kept its dividend flat.
But investors keen to benefit from banks' recovery would be better placed looking in euro zone blue chips, where financials are the biggest contributor to dividends, with 30 percent of the total Euro Stoxx 50 <.STOXX50E> payouts.
(Reporting by Helen Reid)
By Helen Reid