The UK market is renowned for its dividend paying abilities, with several well-known stocks such as Royal Dutch Shell and HSBC commonly held in income portfolios. However, 2020 may tempt investors to reconsider their options.
UK dividend cuts could spur structural shifts in equity sector allocations
Covid-19 and political tensions have disrupted global supply and demand, causing share prices and dividends around the world to fall. Dividend payments in the UK’s FTSE 100 this year are forecasted to fall by roughly a quarter which could see around £18bn shaved off total pay-outs with the bulk stemming from big cuts in oil majors and the suspension of pay-outs from major banks which the FTSE is heavily weighted towards. The pandemic has placed greater emphasis on cash preservation, with companies across the UK initiating cost saving strategies including dividend cuts which have been employed by around a third of FTSE 100 companies to support security and liquidity.
Historical concentration risk in UK Income Equities
There has always been an element of concentration risk when it comes to investing in UK income stocks, with the top 10 dividend payers forecasted to pay over half of the FTSE 100 pay-outs this year, according to Fact-set estimates. In this select group of companies are the likes of BP, Shell and BAT. When we look at these types of companies, who even before Covid-19 had question marks surrounding the sustainability of their pay-outs, particularly when taking into account the longer-term transitionary phase they are currently in, it was inevitable that dividends at some point had to give.
One positive we can take from this economic shock is the opportunity for companies to rebase their dividends. Pre-crisis, coverage ratios were looking tight generally and now companies have had to adapt, we could start to see a new basing of dividends which should be more sustainable going forward.
Equity sector allocation shifts likely as a result of pandemic
We may see new faces emerge as income payers as a result of the structural shifts caused by the pandemic. Investors may start to move away from the traditional income payers and towards companies that have more sustainable and less-disruptive longer-term futures which are cash-generative, thus having the ability to sustainably grow dividends into the future.
One company we like from this angle is BAE Systems, which operates in the aerospace and defence market. The company is more focused on longer-term government contracts providing longer-term secure cashflows. Even though BAE Systems cut dividends earlier in the year as a precautionary measure, the Group has since reinstated them as demand remained high and management had greater visibility heading into H2. The business continues to push on with new acquisitions, leveraging their expertise in more areas of defence giving them a better chance to win new contracts. The advantage of BAE Systems being able to generate secure, long-term cash-flows in a growing market should give it a sustainable base to grow its dividend over time.
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