The Daily Telegraph - Saturday - Money
The outlook for dividends in 2018 – sector by sector
Can investors expect bigger payouts this year? James Connington looks at dividend prospects for each area of the stock market
Although interest rates in Britain have begun to creep up, incomeproducing assets remain highly prized. Major dividend payers such as Lloyds and Vodafone are often among British investors’ most traded stocks. Overall, 2017 was a good year for dividends, with double-digit growth. But what does 2018 hold? Telegraph Money spoke to professional investors for a sector-by-sector breakdown.
The mining sector’s collapse in 2015, when commodity prices fell, forced firms to make efficiency gains. Stephen Bailey, manager of Liontrust Macro Equity Income, said: “Spending has been reined in and a focus on generating cashflow is allowing for increased dividends.”
In 2017 Rio Tinto more than doubled its interim dividend while BHP Billiton tripled its final dividend.
Mr Bailey expected “double-digit dividend growth in percentage terms” in 2018, adding that dividends should be well covered by profits. He highlighted Glencore. “Glencore is unique in generating 40pc of its profits from materials used by electric vehicles. Debt reduction has also permitted more generous dividends.” The risks for miners include a return to bad spending habits and changes in Chinese demand for materials, he said.
Since the financial crisis the amount of spare capital banks have to hold has increased significantly. These requirements must be met before any dividends can be paid.
Sue Noffke, manager of the Schroder Income Growth trust, said: “Banks are at the mercy of regulators. This year requirements increase again and there are some accounting regulation changes too, which will put dividends more at risk in a market downturn.” Barclays and RBS face potential fines in the US relating to the financial crisis, although payment protection insurance claims, which cost banks billions, will cease in 2019.
Ms Noffke said Lloyds and HSBC were her preferred income options. “Lloyds’ dividend growth should be in the double digits. It depends on whether the bank chooses to keep paying special dividends or buy back some of its own shares instead. HSBC is committed to a flat dividend but still has an attractive 5pc yield.”
Insurers also face new capital requirements, introduced in 2016. “Most of them are above the top end of comfort ranges, so the question is how they return the excess to shareholders,” said Ms Noffke.
Legal & General is “attractive from an income perspective” – it yields 6pc and its current 7pc dividend growth rate “is sustainable”.
“Aviva is benefiting from acquiring Friends Life and plans to increase its dividend from 50pc to 60pc of earnings, which could provide double-digit growth from an already attractive 5pc yield,” Ms Noffke added.
Her preference was for life insurers as they were attractively priced and their dividends were well supported. “Non-life insurers such as Direct Line, Admiral and Hastings have been major payers of special dividends. That could stop if inflation increases or there are spikes in claim numbers.”
In 2017 Royal Dutch Shell reinstated its cash dividend – previously shareholders could elect to take shares – and BP announced a share buyback scheme, but there are significant doubts about the sector.
Mr Bailey said 2018’s forecast dividends would barely be covered by profits and he foresaw an oil price fall putting dividends at risk. “The oil majors carry a lot of debt, which with rising interest rates could put pressure on dividends. They are also dependent on a $50-plus oil price to support current dividend levels,” he said. Although Opec’s production cap has maintained prices so far, “higher oil prices may prompt members to renege on their production limits”.
Mr Bailey added: “This would drive down oil prices, putting pressure on dividends. We think dividends remaining flat is a best-case scenario.”
The tobacco sector has proved resilient, although shares have arguably become expensive.
William Meadon, manager of the JP Morgan Claverhouse investment trust, said: “British American Tobacco and Imperial have stable dividend policies. We expect Imperial to grow its dividend by 9pc next year, but it has recently removed dividend targets. For BAT our prediction is a conservative 5pc increase.”
The sector had dividend cover of 1.3, meaning payouts were relatively thinly covered by profits. One risk stems from plans by the US regulator to cut nicotine in cigarettes to nonaddictive levels. America is a major market for both BAT and Imperial.
“This may come into play in 2018, but the timeline is unclear,” said Mr Meadon. US tax reforms could be a supporting factor, with BAT’s tax rate potentially falling from 33pc to 27pc.
The utilities sector faces tougher price controls from Ofgem, the regulator, and the Government’s proposed cap on energy tariffs.
Mr Meadon said water companies also faced pressure from a regulatory review, “but this shouldn’t affect dividends until 2020”. He added: “In 2018 the dividends of National Grid, Pennon, Severn Trent and United Utilities are all supported by existing regulatory frameworks. None of these dividends will be immediately at risk, and they are well supported.
“National Grid will maintain its above-inflation dividend increase, but the sustainability of that policy remains to be seen. It has the lowest dividend cover in the sector.” SSE plans to continue increasing its dividend by more than inflation in 2018 and 2019, but thereafter it would probably be cut because of a split in the business, Mr Meadon said. He added: “Centrica is the dividend we’re most concerned about. Its core source of cash, British Gas, has been losing customers rapidly.”
Rising share prices have kept yields on consumer staples stocks relatively low, at an expected 2.8pc next year. But these stocks’ dividends have a healthy level of cover of 2.3, meaning dividends could be paid more than twice over from profits. Chris White, who runs the Premier Income fund, said: “Generally, dividends are stable. But many firms have significant overseas earnings, so the pound’s recovery from its postreferendum lows may be a drag. “Dividends at Reckitt Benckiser, Diageo, Unilever and AB Foods look robust.”
AstraZeneca and GlaxoSmithKline suffered significant share price falls in 2017, although the former has somewhat recovered.
Chris Beauchamp, of trading service IG, said: “Overall, the sector’s yield is forecast to remain steady at 3.9pc, but AstraZeneca is expected to boost its dividend yield to 4pc from 2.7pc, and GSK’s is expected to rise from 5.9pc to 6.1pc at current share prices.”
GSK’s high dividend meant it had less capital to boost its pipeline of new drugs.
“The question is whether the share price could stand a significant dividend cut, even if it allowed the firm to compete,” Mr Beauchamp said.