Slowing dividend growth is currently afflicting the UK, says Adrian Frost of Artemis, but the tide may turn later this year.
Headline growth figures for UK dividend payments in 2015 were skewed by Vodafone’s £16 billion dividend payment the previous year – the largest single dividend payment ever made.
Thus a 2015 headline fall of 10% year-on-year belied what was in fact a relatively healthy 12 months in terms of income from UK equities. Compared to 2013, a more typical year, UK dividend payments in 2015 were up almost 9%, according to figures released this month by Capita.
If the 12-month figures look respectable, the recent trend is more negative, according to Adrian Frost of Artemis, and that is unlikely to change in the near term.
“The UK dividend outlook is particularly challenged at the moment due to the FTSE’s high dependence on large companies in the oil and mining sectors and, to a lesser extent, in the banking sector,” says Frost. “These areas have got their challenges and we have already seen some dividend cuts.”
In great part due to the falling oil price, last year saw a particularly strong divergence between the best and worst-performing stocks on the FTSE, Frost points out. In the case of oil and mining companies, there could be dividend cuts to come this year.
Royal Dutch Shell, which announced a 40% dip in earnings for the fourth quarter, recently said it would maintain its dividend payments, even though the company predicts that 2016 dividend cover – how many times earnings cover dividend payments – will sit at the exceptionally low ratio of 1:1.
“Companies with little control of their destiny suffered badly last year and so the oil majors were of course particularly vulnerable,” says Frost. “However, the poor performance of these stocks in recent years, and their high yields, suggest dividend cuts have been anticipated – so the downside should be modest.”
Frost and Adrian Gosden, co-managers of the St. James’s Place UK & International Income fund, already sold down significant holdings in the oil sector earlier in 2015, but chose not to exit entirely.
“We would like to see some growth again, and the way we have been positioned thus far is to sacrifice some higher yield for growth as we choose companies,” he says. “That is unexciting in the short term; but if our strategy is right, then we should start seeing some dividend growth coming through.”
The divergence in FTSE fortunes means that some companies were forced last year to reduce their dividend payments, as in the cases of Wm Morrison and J Sainsbury, or even to cancel them entirely, as in the case of Tesco.
The supermarket sector has been particularly hard-hit in recent months. Food and drug retailers paid out 57% less in dividends last year than in 2014, according to the latest Capita figures. (In fact, the New Year has brought what may be the first signals of an improvement for the sector; fourth quarter results for both Wm Morrison and Tesco beat expectations.)
The extent of divergence between what Frost calls the “haves and have-nots” has also offered the opportunity to benefit from additional income. He points to his fund’s investments in Direct Line and Persimmon as examples of stock picks that have been fruitful not only in terms of capital growth but also dividends.
“We have a group of successful stocks which has achieved good capital performance but this hides the fact that, in some cases, they’ve given out an extra 40% in ordinary and special dividends,” says Frost. “These are usually those holdings with opportunity for self-help – well-capitalised companies in ‘steady Eddie’ areas. We think they can continue to offer some dividend growth and that it need not be at the expense of capital growth.”
In the immediate term, the wide divergence in corporate fortunes means that active management will be all the more important in securing the level of income investors are looking for.
“When it comes to the bull market we have been enjoying since 2009, we have clearly hit a kind of limit,” says Frost. “Companies’ share prices have grown but corporate growth has disappointed. Whilst we have a possible year of headline dividend cuts ahead, share price reaction may not be hugely negative, as a degree of the dividend uncertainty is already priced in.”
1 Capita Asset Management, website accessed 26 January
The opinions expressed are those of Adrian Frost of Artemis, and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James's Place Wealth Management.