By Michelle McGagh of Citywire
Sterling weakness helped dividend pay outs reach a new record in the last quarter of last year but investors shouldn’t bank on the rise continuing in 2017.
The latest Capita Dividend Monitor reveals 2016 fourth quarter dividends comfortably reached a new record of £16.6 billion – an 11.7% year-on-year increase. The end of the year also marked another annual record as dividends climbed to a total of £84.7 billion over the year, a 6.6% rise on 2015.
A raft of special dividends coupled with weakness in the pound were behind the increase. Two-fifths of UK dividends are denominated in dollars and euros and therefore translated at a more favourable exchange rate as the pound struggled post-Brexit.
Special dividends more than doubled to £6.1 billion over the year, adding to the headline figure.
However, investors should not be lulled into a false sense of security about the future of their income stream as underlying dividends, which excludes special payments, are rising at a slower rate of 2.6% to reach £78.5 billion in 2016.
Take away the exchange rate gains and this figure falls further to £73.3 billion, 3.7% lower year-on-year.
This points to the difficulties companies have in improving profitability, which could have a knock-on effect on dividends.
Justin Cooper, chief executive of shareholder solutions at Capita Asset Services, said investors would be ‘looking for improving profitability…and for this to feed through into underlying dividends, so that improving payouts are more sustainable and less dependent on currency gains’.
Investment analyst at The Share Centre Helal Miah said the quarterly and annual increases from currency fluctuations would ‘fade away’ and ‘cannot be relied upon for dividend growth’.
‘In a low-growth world, it is important for investors to think about prospective income growth rather than companies where a high dividend yield may be a legacy of the past,’ he said.
‘Cashflow sustainability should be the starting point with income investing, not the headline dividend yield. Understanding how a management team allocate capital for the medium term is an important and sometimes neglected aspect of stock picking, where the focus of many market participants is so often the short-term performance.’
Miah expects dividends from commodity-focused companies to pick up this year although the benefits will not be immediate. Shell remained the UK’s largest dividend payer last year, and is now the largest payer in the world, with a total dividend worth £11.1 billion last year, £3.2 billion more than the year before.
HSBC is the second highest payer distributing £7.5 billion and GlaxoSmithKline comes in third.
‘One of the key drivers for how dividends have shaped up is the commodity sector,’ he said.
‘The big oil companies maintained dividends even though there was pressure to cut them because they have deep pockets…the mid-cap companies have more debt and were more impacted in the oil sector…Recently we are seeing positive signs but we will not see a pick-up in dividends yet as commodities need to be a bit more sustainable, but things are looking better.’
Although house builders have been hit by Brexit and fears about a slowdown in the housing market, Miah believes there will still be ‘good dividends this year and next year’ from the sector.
However, he said the pace of the dividends would ‘moderate’ as companies will have to invest in new housing stock and plots.
Investors should be wary of looking for dividends from the retail sector and supermarkets, which continue to operate on low margins and are unlikely to get back to where they were several years ago ‘when they enjoyed margins of 3-4%’, said Miah.
For investors interested in retail, Miah said they should focus on companies who had a strong online presence and were willing to invest in technology.
‘Overall, I would say we have a relatively positive stance [on UK dividend opportunities] but the short-term boost is only short-term,’ he said.
Cooper agreed that 2016 was an ‘unusual year’ as special dividends and currency devaluation transformed a gloomy outlook for payouts into a ‘golden’ year for dividends.
He said there were still uncertainties caused by US president Donald Trump’s plans and Article 50 being triggered.
‘Nevertheless, economic growth is holding up in the UK, improving in Europe, and may take off in America,’ he said.
‘Commodity prices are climbing back, providing relief for oil and mining firms. We should also see some of those companies that cancelled dividends in recent years reinstate them.’