Dividends at highest risk of cuts in 7 years

Companies paid out a record £33.3bn in dividends in the second quarter of 2017 – but are the payouts sustainable? One major factor that has driven up dividends is the weakened pound, as dollar and euro payouts have been converted into sterling at a much more favourable rate.

The headline figure also includes “special” payments of £4.6bn, according to data from consultancy Capita. These generally represent one- off returns of capital to shareholders, typically linked to a firm’s restructuring or sale of an asset. For instance, National Grid returned £3.2bn to shareholders after selling a majority stake in its gas network.

The £33.3bn represented a 14.5pc increase on the same quarter last year. Around two percentage points of that was accounted for by special payments, and seven percentage points by the weakened pound. That still suggests significant underlying dividend growth.

However, companies’ managements can decide to make dividend payments even where there is inadequate profit growth to support them: they could pay dividends from funds otherwise earmarked for investment in the business, or they could even borrow in order to pay dividends.

And the sustainability of these payments is in question.

Research from investment shop the Share Centre reveals that the average dividend cover – the ratio of profits to dividend payments – of Britain’s largest 350 companies has fallen to just 0.8, a seven-year low.

Typically, dividend cover of two or more is considered desirable for dividends to be deemed secure. A stock with cover of less than 1.5 is seen as being at risk of a dividend cut. Looking at 2016 profits reported by March 2017, the research found that the profits across the 350 companies fell by 7.6pc compared to the previous year. Over the same period, firms increased their dividend payouts by 7.1pc. This had the effect of reducing dividend cover from 0.97 to 0.8.

Oil and mining companies have played a major part in this. Oil stocks, such as BP and Shell, are the UK’s largest dividend payers, and did not cut their dividends despite the pressures of the oil price crash. Now, despite returning to profit thanks to the recovering oil price and efficiency drives, they are still paying out many times that profit in dividends.

The FTSE 250, which has a higher proportion of smaller companies, has a more promising cover level of 1.2, according to the research, but has seen a larger fall in this cover. Dividend payouts among these companies have increased by 3pc, despite a 16pc fall in net profits.

Some sectors of the UK market are more at risk of a cut than others.

The telecoms, mining and oil sectors have dividend cover of less than 0.5. Bank, financial, healthcare, pharmaceutical, industrial and information technology companies all average dividend cover of less than one. That means among those sectors, companies are paying dividends through means other than profits – whether using up cash reserves, selling off assets or taking on debt.

The most secure sectors are housebuilders, consumer services, and utility stocks, all of which have dividend cover of 1.5 or above.

Some individual companies appear particularly at risk. For instance, FTSE 100 retailer Marks & Spencer has a dividend yield of 5.7pc, but cover of just 0.38, according to screening service Stockopedia.

The brand’s clothing lines have been struggling, and a restructure has hit profits. No dividend cut has been mentioned, but it has a track record of cutting payouts – as happened in 2000 and 2009.

Out of the 19 FTSE 100 stocks yielding more than 4.5pc, only two have cover greater than 1.5 – the minimum threshold for a dividend to be considered secure,

Helal Miah, of the Share Centre, said: “Dividend cover is still weakening, and this should ring alarm bells for income investors, especially as the outlook for the British economy is declining.

“Consumer spending is down, manufacturing growth is slowing, and the housing market is slowing. For domestically- orientated companies, this will impact profits, which will likely weigh on dividends.”

However, he added that the UK’s 100 largest companies are showing signs of improving profitability, commodity prices have increased, and global growth is strengthening – all of which should filter through to result in larger profits.

Reductions now more likely than at any point since 2010, says James Connington