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Income: dividend cover dives into dangerous waters

Company profits are down but dividends to shareholders are up. The result? A further worrying decline in dividend cover for income investors.

 
Income: dividend cover dives into dangerous waters
 

For the UK’s largest listed companies, dividend cover – the ratio of a firm’s profits to the dividends it pays shareholders – has plummeted to its lowest level since 2009. Yet fund managers are confident this will improve.

The dividend cover ratio among the largest 350 stocks has dropped 18% year on year, to just below 0.8 times, according to analysis by The Share Centre. While FTSE 350 company profits to the end of December 2016 fell 7.6%, to £67.3 billion, dividends for the same stocks increased 7.1%, to £81.1 billion. This continues a trend of recent years: two years ago dividend cover from earnings stood at 1.2 times, having fallen from 1.5 in 2014. 

Cause for concern?

Dividend cover weakening at the same time as the outlook for the UK economy is moderating will ring alarm bells, according to Helal Miah, investment research analyst at The Share Centre. ‘Consumer spending is down, manufacturing growth is slowing, and the housing market is slowing,’ he said. ‘For domestically oriented companies, especially those in the FTSE 250, this will impact sales and profits, and is likely to weigh on dividends.’

Low dividend cover is due to depressed earnings, strange accounting or over-distribution of the dividend, according to Julian Cane, manager of the F&C Capital and Income (FCI ) investment trust. ‘Sectors with the lowest cover include oil, banking and pharmaceuticals, particularly the largest stocks within them,’ he said.

He highlighted some key examples. ‘HSBC’s [HSBA] reported dividend cover is less than one, due to restructuring charges and exceptional costs, as is Royal Dutch Shell [RDSb],’ he said. ‘BP’s [BP], GlaxoSmithKline’s [GSK] and AstraZeneca’s [AZN] dividend covers are all below 1.5 times.’

Road to recovery

Many fund managers remain optimistic and argue projections indicate dividend cover of around 1.7 times for the current year. Michael Clark, manager of the Fidelity MoneyBuilder Dividend fund, said: ‘There’s been a focus on generating cash, getting balance sheets in order and paying a dividend out of cashflow.’

Insisting there were no widespread signs of corporate stress, he said, ‘Things are looking very supportive, especially given that economic growth continues.’

He said improvements in the oil sector had helped to boost the outlook for dividend cover in the FTSE 100. ‘Earnings and cashflow have recovered, the oil price has come up from its lows, and the oil companies have got to grips with their costs,’ he said.

Brighter outlook

Clark has also found opportunities in UK domestically focused names, such as British Land (BLND), which have been adversely affected by political concerns surrounding Brexit. ‘The market fears the worst about the UK and it’s probably not going to be as bad,’ he said.

Sanjiv Tumkur, head of equity research at Rathbones, said the outlook for dividends depended on corporate profits and believed these to be strong, despite Brexit concerns and the lack of infrastructure spending in the US. ‘Dividend cover isn’t as high as it used to be, but company managements are very focused on rewarding shareholders and dividends are regarded as important,’ he said. ‘As long as earnings continue to trend upwards then dividends should do as well.’

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  • Fidelity MoneyBuilder Dividend A Inc
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  • HSBC Holdings PLC (HSBA.L)
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