Following BT’s decision to cut its dividend, we comment on the outlook for UK income investors.
Dividend cuts: The Story so Far
For many investors dividends are one of the key motives for investing in equity markets, especially over the last decade when alternatives were rather poor. Unfortunately for equity investors another disaster scenario has appeared from the Covid-19 outbreak and with most economies virtually shut down, consumers are stuck at home, workers are lying idle and company’s cash inflows have stopped.
With cash inflows having stopped, cost cutting is a major feature while also looking for cash from other sources to plug the gap from bank loans supported by governments to capital raising through the bond and stock markets. But for most, a dividend cut is the simplest and most straightforward way to save cash.
Since this crisis started we’ve never seen so many companies cut dividends in such a short period of time. Since the beginning of March until the 1 May, 351 companies across all UK indices have announced some form of a cut. Whether that’s a dividend suspension, a cut or a cancellation with the vast majority of them looking to pay nothing on their next scheduled payment date and a few indicating no payments for the remainder of the year.
Of those that announced a cut, 41 of them are from the FTSE100, 98 from the mid-cap index and remainder are smaller companies from the All-Share, Small cap, AIM and Fledging indices. In terms of numbers then, smaller companies account for the majority of companies affected by the disaster.
But when it comes to income investing, it’s the big FTSE100 companies where attention should fall upon. With the cuts announced so far, we estimated a total of just under £17bn in dividend distributions has been lost at this interim stage (not accounting for subsequent interim dividend cuts for the remainder of the year).
Royal Dutch Shell’s dividend cut has grabbed the headlines and speaks well of the current situation having never cut a dividend since the Second World War. Its cutting of quarterly dividends will save it just under £2bn and potentially up to £10bn if the remaining interims for the rest of the year are held at a third of last year’s levels. With BP holding out so far, preferring to raise debt rather than hit shareholders directly, the oil sector is not the largest contributor to the slump in dividends among the FTSE100 stocks.
That accolade goes to the big banks – HSBC, Lloyds, Barclays, RBS and Standard Chartered, each of which has cut its interims to zero. Collectively they cut their interims by roughly £7.5bn, almost half of the total in the UK. HSBC’s cut is the big one, even bigger that Royal Dutch Shell, taking its quarterly dividend from 21c to zero equivalent to roughly £3.4bn.
While small in terms of market cap relative to the FTSE giants, UK housebuilders have been a good source of income in recent years and despite some encouraging order book numbers, companies in the sector have announced major cuts. The sector as a whole has slashed investor pay outs by roughly £1.3bn, the majority from Persimmon and Taylor Wimpey who have cancelled their latest interims along with the special dividends as well. So far, the London focussed Berkeley Group has held out from cutting.
The worst hit sector in this crisis is the travel sector. In the top index IAG has cancelled its dividend, easyJet is yet to give any further indication having just paid, while TUI is no longer represented in the index but will no doubt cut to zero.
A Mixed Picture for UK plc
There are other well-known dividend paying sectors where investors will be relieved to hear dividend pay outs so far don’t reflect the disaster scenario:
- The other well-known dividend payers are the utilities and here only Centrica has cut its dividend but it has had many other issues apart from lower energy prices. The other electricity and water utilities so far are carrying on
- Major miners are also important dividend payers and here the two largest, and our preferred miners BHP and Rio Tinto, seem to be doing reasonably well with iron ore prices holding up well as China gets back on its feet. At the same time Glencore has cancelled its next two interim 10c dividends and Anglo has cut it’s by a small amount
- Dividends in the life insurance sector have also held up well, with so far only Aviva announcing a cancellation of its 21.4p dividend
- Meanwhile, going strong are the two giant pharmaceuticals, GlaxoSmithKline and AstraZeneca (whose shares have reached new all-time highs), both of whom should see little negative impact from the virus and are working on vaccines or remedies
We’re yet to hear from other big dividend payers such as Vodafone and Diageo, while Tesco and Morrisons, who have done well in the current circumstances, could follow their peer Sainsbury’s by still cutting the pay-out.
Outside the FTSE 100
Outside of the top FTSE100 and therefore the more UK focussed group of companies, financial services represent the largest number of companies to have announced cuts. But this should not be a surprise since there are so many financial companies in the UK market. Of these, the real estate groups are well represented.
While a lifting of the lockdown in the UK looks like it’s on the horizon, I feel we’re still in the early days of finding out the true economic damage. There seems to be some belief among investors that as soon as the lockdown is lifted and life returns to some form of normality, company dividends will get back to where they were prior to the crisis. While there will be a few examples of companies who restore their dividends quickly, at the aggregate level this will not be the case. Unfortunately, dividend payments, much like the economy are not binary in nature. Upon the lifting of the lockdown, the economy doesn’t just carry on from where it left off and dividends don’t just resume.
Many businesses will permanently disappear, while many people will have lost jobs and incomes among consumers will have taken a dive as Government schemes will not totally compensate. Consumer confidence will take time to rebuild and the economy will recover but it may be gradual.
After the financial crisis, it took about three years for dividends to resume to prior levels. This crisis is deeper, and with no v-shaped recovery in sight, it could take even longer for dividends to fully recover at the aggregate level.
Where should investors go for income?
They may have to concentrate on even fewer sectors such as utilities and pharmaceuticals or other defensives such as food producers and supermarkets. However, while supermarkets are doing well now, once the lockdown is lifted the issues they faced before such as competition from the German discounters may get even more intense.
Existing income investors will not be comfortable with the current situation, but investing is for the long term, the economy will recover and so will dividend distributions. While dividends have been cut, the yields on the market as a whole has roughly kept in-line and prices too have fallen back. Therefore, for income investors looking to put money away, now is a good time as any.
Finally, direct equity investing may not be for everyone and the funds route may be a more appropriate option. For investors wanting dividend income to be smoothed over time they may want to consider an income focussed investment trust. These have unique features which allows them to hold back dividend income from underlying investments in the good times, effectively a buffer, in order to continue paying out in the bad times, which is exactly what some of the investment trusts are doing now.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.