As uncertainty grows, companies slam the brakes on dividend payouts.

  • We expect UK dividend payouts to decline
  • Travel & leisure and retail companies are most affected, so far
  • Dividends are relatively better protected across health care, utilities and consumer staples
  • Balance-sheet strength remains key – irrespective of the sector 

Over the last decade, investors in UK equity income funds have benefited from a healthy level of income from their investments, with attractive total returns and often less volatility. From 2010 to the end of 2019, the Investment Association’s UK Income sector outperformed, generating a return of 124% versus the FTSE All-Share Index’s 118%.1 While investors have experienced volatility in capital returns, dividends have been steadily rising. However, those hoping for another increase in dividends in 2020 are set to be disappointed. We expect dividend payouts to decline.

Source: Link Group: ‘UK Dividend Monitor: Issue 4’, Q4 2019

As we contemplate the impact coronavirus could have on UK dividend payments, it is helpful to look back at the last time dividends were cut. In 2009, the distribution from FTSE All-Share companies fell to £54bn, from £61bn in 2008, a 13% fall.2 Back then, the majority of the dividend cuts came from the financial sector, with memorable cuts to zero by Royal Bank of Scotland, Lloyds and HBOS, but also sizeable cuts by Barclays, Aviva and HSBC. Companies with highly levered balance sheets also made sizeable cuts – BT cut by 59% and Marks and Spencer by 33%.3 

While we don’t expect history to repeat itself, we know it often ‘rhymes’. There are some key similarities between the outlook today and what happened in 2008. A study by Société Générale, which analysed dividend cuts greater than 10% in 2009, found that the majority (75%) came from companies with weak balance sheets, as defined by a Merton score.4 We expect that this will again be a major indicator of a company’s ability to pay dividends through the current crisis. Interestingly, some cyclical sectors, like mining, enter this downturn with significantly stronger balance sheets than in 2008, which could help them weather a temporary decline in revenues.

Source: Link Group: ‘UK Dividend Monitor: Issue 4’, Q4 2019

While the coronavirus shutdown will affect all sectors, those experiencing the most immediate impact are travel & leisure and retail. Already we have seen several dividend cuts and postponements. InterContinental Hotels Group cancelled its April dividend and said it would defer consideration of further dividends until visibility improved. Marks and Spencer cancelled its May final dividend and said the interim payment would be reviewed in November. Next has cautiously replaced its final dividend due in July with a second interim payment. Inditex, owner of the Zara brand, which is listed in Spain but an interesting example for UK retailers, has decided to postpone its April dividend to a decision in July.

Arguably the biggest risk to UK income payouts is in the energy sector. If the oil price stays in the $20s for any length of time, it is likely that the dividend payments of BP and Shell would exceed their profits this year and therefore would have to be paid out of debt. In this scenario, we expect both companies to consider rebasing their dividends to a lower level. However, we would not expect them to cut to zero. At the end of 2019, the oil, gas and energy sector accounted for 17% of dividend distributions in the FTSE All Share Index, according to the Link dividend monitor. While this may seem daunting, we should remember that financials made up nearly one-third of dividend payments in 2007, when the overall cut was just 13% and income recovered to pre-crisis levels within two years. 

As in 2009, there will be some sectors where dividends are likely to be relatively better protected, including health care, utilities and consumer staples. However, balance-sheet strength remains absolutely key, irrespective of the sector. 

We believe our income strategies’ orientation to stable businesses with low levels of leverage and with exposure to areas of structural growth as supported by our thematic research, is a significant help in this environment. We deliberately target companies with the ability to suffer. When studying potential new holdings, or existing ones, we spend more time analysing what can go wrong than what can go right. While the companies we hold will be affected by this current crisis, we hope this type of analysis will stand our portfolios in good stead in the coming months and when the recovery eventually arrives.

Sources:

  1. Lipper 31.12.09 to 31.12.19.
  2. Link Group: ‘UK Dividend Monitor: Issue 4’, Q4 2019.
  3. The Telegraph: ‘2009 dividend cuts from big companies’, 19 May 2009.
  4. MoneyWeek: ‘Are your dividends under threat?’ 5 May 2015. The Merton score is a recognised balance-sheet model that estimates the distance to default of a company. The stronger the firm’s finances, the higher the score.

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