By Michelle McGagh of Citywire
Dividends have increased £2.5 billion due to the plunging pound, bringing cheer to income investors but the boost is not the full story.
The weakness in sterling seen since the EU referendum saw dividends reach £24.9 billion in the third quarter, according to the latest Capita Dividend Monitor.
The total amount of dividends paid out has risen 1.6% year-on-year to shrug off £2.2 billion in cuts that hit over the period, mainly from the mining sector.
The underlying dividend total, excluding special dividends, increased 2.6% year-on-year to £23.9 billion.
The increase in pay outs has come from the large dollar and euro-denominated dividends that are paid by multinationals such as Shell, HSBC and Unilever. When translated into sterling, the dividends become much more favourable and led to the £2.5 billion currency gain, far above the £1 billion predicted by Capita post-Brexit.
Capita said it was the largest exchange rate effect in any quarter since the financial crisis when the pound slumped from over $2 in 2008 to $1.38 in 2009.
Adding to the currency benefits was a final payment from drinks giant SAB Miller (SAB), which paid its dividend just before its acquisition of AB InBev. It paid a dividend of £1.2 billion in August, 28% higher than last year and although the large sum reflected the plunging pound, in dollar terms the dividend was still 8% higher.
As oil prices continue to rise, oil producers also increased pay outs by 23%, with an additional £790 million ‘seemingly at odds with the sharp decline in profits at BP (BP) and Shell (RDSA)’, said Capita.
However, the increase was due mainly to the effects of the more generous dividends being paid by new Shell shares issued when it took over BG.
While oil producers increased dividends, the biggest dent came from mining, with cuts from Glencore (GLEN), BHP Billiton (BLT), Rio Tinto (RIO) and Anglo American (AAL). Collectively the companies aid out £1.9 billion, down 68% on last year despite a 20% boost from weak sterling.
Capita said further cuts are still in the pipeline as the mining sector ‘rebases dividends to reflect the lower commodity prices, but the worst is now behind us’.
Overall, 25 sectors increased payouts compared with the 14 that saw them fall, although those cutting dividends made a ‘disproportionately large impact’.
Justin Cooper, chief executive of shareholder solution at Capita Asset Services, said investors are set for another currency windfall next quarter.
‘In the short term, the pound’s fall is super-charging UK dividends,’ he said. ‘We estimate that Q4 will see another currency windfall of almost £1.7 billion, taking the total for 2016 to over £5.6 billion.’
The expectation for increased dividends ‘explains why FTSE 100 share prices have been strong so far in the second half of 2016’, said Cooper, and ‘as the translated sterling value of cashflows earnings in foreign currencies rises, so the sterling value of share prices moves upwards in lock-step to reflect the devaluation of the pound’.
Russ Mould, investment director at AJ Bell, the fund and pension broker, said ‘mathematically’ the Capita predictions for further windfalls were right as ‘40% of dividends are paid in US dollars’, such as Shell, BP and the large pharmaceutical stocks.
On the surface, dividend payments look attractive but Capita said stripping out the positive affects of currency exchange reveals a disappointing picture, affected by high profile dividend cuts.
Pay outs were actually 0.1% lower year-on-year in the third quarter as weak profitability in the UK’s largest companies and growing pension deficits made it difficult to increase dividends.
Cooper said he expected more cuts in the fourth quarter and ‘without this devaluation…underlying dividends will fall in 2016’.
The dividend landscape is being overshadowed by multinational companies and Cooper said ‘the UK’s largest companies are easily overshadowing better growth among the mid-caps’.
Mid-cap dividends outperformed the top 100 again, continuing a two-year trend, rising 4.9% to £2.7 billion, compared to 0.9% growth in the top 100 companies.
Capita said mid-cap companies have been ‘more insulated from the succession of negative trends to hit the profits of the top 100’, including weak commodity and oil prices, banking sector difficulties and supermarket price wars.
Mould added that dividend growth ‘assumes that companies stick to their dividend plans and do not cut them’.
Although currency is helping increase dividends, as is a rising oil price which is feeding dividends from BP and Shell – which between them make up a fifth of dividend payments in cash terms – Mould was concerned about dividend cover.
He said dividend cover was ‘worryingly thin’ and 48% of FTSE 100 firms have earnings that cover their dividends by less than two times.
‘I think we have to be careful because dividend cover is very thin,’ he said. ‘Last year payout ratios as a percentage of net profits was at an all-time high of 75% when long-run you do not want to see that above 50%.’
Mould said he wanted to see dividend cover of 2.5x-plus as it ‘gives companies the slack to pay dividends in the long-term’ if there is a recession or problem within the company.
‘If you start with low dividend cover then there could be cuts [to the dividend if something goes wrong],’ said Mould. ‘We have seen 12 or more cuts in dividends in the past 18 months.’