By Gavin Lumsden of Citywire

The FTSE All-Share index may have recovered from last week’s shock ‘Brexit’ referendum result but not everything in the UK stock market has gone back to the way it was before 23 June.

This most visible change has been in the companies leading the stock market in terms of the dividend yields they offer.

Whereas before the referendum oil stocks BP (BP) and Royal Dutch Shell (RDSb) were prominent high yielders (see second table below), they have been ousted by banks and house builders and other companies exposed to the UK housing market.

It’s not that the oil giants have stopped being high yielders. With yields around 6.6% they are still a huge source of income for investors. It’s just that fears that a slowing economy have hit the property market and seen shares linked to it plunge by around a third since the referendum.

Banks like Lloyds Banking Group (LLOY) have tumbled by 25%, while other financials, such as Standard Life (SL) and Legal & General (LGEN), have slid a similar amount.

That’s painful for their investors but for income seekers it provides potential opportunities. Providing these companies can maintain their dividend payments it means a higher dividend per share, or yield, for new investors.

As a result Lloyds has leaped to the top of the dividend league (see first table), yielding 8.1% assuming it goes ahead with plans to increase its dividends from 2.25p to 4.38p a share next year. Those payments look secure given they are covered 1.7 times by forecast earnings, but of course those forecast profits may prove illusory if house prices and lending volumes suddenly drop in a downturn.

Yield (based on
forecast earnings) %
Dividend cover (based on
forecast earnings)
Lloyds Banking Group (LLOY)  8.1 1.74x
Taylor Wimpey (TW)  7.8 1.61x
Berkeley Group (BKGH)  7.6 1.97x
Legal and General (LGEN) 7.5 1.41x
HSBC Holdings (HSBA) 7.2 1.22x
Persimmon (PSN)  7.2 1.69x
Direct Line (DLGD)  7.1 1.14x
Barratt Developments (BDEV)  6.9 1.89x
Marks and Spencer (MKS) 6.7 1.46x
Standard Life (SL)  6.6 1.33x
Source: AJ Bell 5/7/16

Russ Mould, investment director at online stock broker AJ Bell, who compiled the tables, said: ‘The FTSE 100 is now forecast to yield around 3.5% this year, down from the 4% forecast pre-referendum as a result of the index’s rally since the “Brexit” vote.

‘At the top of the table there are some truly mouth-watering yields on offer but the question is whether these yields are sustainable based on the new outlook for these businesses,’ he said.

Mould said that the fall in Lloyds shares suggested the market was becoming nervous, although we also know investors such as Fidelity fund manager such as Alex Wright are holding their nerve.

HSBC shares have actually been resilient since the referendum, rising 4%, although Mould pointed out its 7% dividend yield looked less secure as the earnings cover at 1.2 times was getting ‘thin’. Investors ideally look for earnings cover of 1.5.

Yield (based on
forecast earnings) %
Dividend cover (based on
forecast earnings)
HSBC (HSBA) 7.7 1.22x
BP (BP)  7.2 0.48x
Royal Dutch Shell (RDSb)  7 0.58x
Direct Line (DLGD)  6.9 1.14x
Berkeley Group (BKGH)  6.3 1.97x
Legal and General (LGEN) 6.2 1.41x
Lloyds Banking Group (LLOY)  6.2 1.74x
Admiral Group (ADML)  6 0.92x
Marks & Spencer (MKS)  6 1.46x
Pearson (PSON) 6 1.03x
Source: AJ Bell 5/7/16

Builders have cash for dividends

But what about the housebuilders, four of whom now sit in the top 10 yielders in our first table?

Analysts at Deutsche Bank believe their plummeting shares are an over-reaction. ‘We believe current dividends can be maintained for at least one-to-two years. Net cash on the balance sheets of a number of UK housebuilders should be sufficient to support our current dividend forecasts for at least one to two years.’

In addition to Persimmon (PSN), which yields over 7%, Deutsche analysts highlighted retirement home builder McCarthy & Stone (MCS), yielding 4.2%, and Bovis (BVS), yielding 5.9%.

Interestingly, given MPs on the Communities and Local Government Committee have just started an inquiry into the capacity of builders to provide new homes, Deutsche added that the firms could further conserve cash by suspending land purchases.

‘Were the housebuilders to stop land spend for six months… we believe this could provide for at least one further year of dividends,’ they said.

There’s a clear tension between the social need for builders to help solve the shortage in housing and their commitment to pay shareholder dividends!

‘Taylor Wimpey is due to offer a 9.2p special dividend pending shareholder approval at this month’s annual general meeting while Berkeley and Persimmon both have clearly defined cash-return programmed laid out for the next five years,’ added Mould.

He cautioned, however, that builders’ profit forecasts and dividend paying capacity were very sensitive to changes in house prices. Deutsche’s analysis shows how a 10% fall in house prices and a 10% fall in purchases would wipe out over half of builders’ earnings. A 20% house price crash would wipe out the sector’s profits whatever the level of transactions, it warned, so it is just as well they are sitting on a cash cushion.

‘Income-hunters need to do their research on the UK economy, the housing market and the builders’ balance sheets and strategies before they decide to take the plunge or not,’ said Mould.

This article is independently written by Citywire and not subject to editorial oversight by Blackrock