The era of easy pickings for income investors could be drawing to a close as more companies come under pressure to slash their payouts
The dividends paid out by FTSE 100 companies have sustained investors at a time of rock-bottom interest rates – but several big name firms have reduced their payouts and several more are likely to do so over the coming months.
Blue chips including Tesco, Rolls Royce, Barclays, Rio Tinto, BHP Billiton, Centrica and Sainsbury’s have all cut their dividends over the last year.
That could be merely the tip of the iceberg, experts have warned. Diageo, Vodafone, Tate & Lyle, Inmarsat and Scotland’s Weir Group all feature on a list of 15 companies viewed by Canaccord Genuity as most at risk of a dividend cut.
Many of the firms singled out by the broker are being stretched by falling revenues, particularly those exposed to the commodities downturn.
James Rae, investment manager at Charlotte Square Investment Managers, said: “Many miners cut dividends at the start of the year and investors remain concerned that there is more bad news to come from the big dividend payers.
“It is a difficult time for commodity stocks; many have the financial strength to pay uncovered dividends for periods of time but eventually reality will have to bite.”
Dividend cuts by the likes of BP and Shell would be especially damaging, with Capita estimating that the latter accounts for £1 in every £7.50 of dividends paid out by listed UK firms.
FTSE 100 companies have been distributing £7 of every £10 of profits as dividends, close to a record high. But their desire to continue paying dividends has caused some to dig too deeply into their resources, putting both their stability and future dividend payments at risk.
The average company with a defined benefit (final-salary) scheme is paying ten times as much in dividends as it is in deficit recovery contributions, the Pensions Regulator warned this week. The fall in contributions means deficits are increasing and the future of those schemes could be under threat.
It all adds to the downward pressure on dividends and means commodities companies are far from alone in having to rethink their payments.
“Some of the UK pharmaceutical giants are struggling to maintain cash generation as patents on blockbuster drugs expire,” said Rae. “Water companies are also struggling to cover dividends as they adapt to recent changes in pricing regulation and the opening of the retail water market in England and Wales.”
So what does this mean for investors? Millions of people with Isa and pension investments have money in income-producing funds, with UK equity income funds especially popular.
It’s not just the income that suffers from reduced payouts, because dividends are also a key driver of growth. The most recent Barclays Equity Gilt study found that if you’d invested £100 in the UK stock market at the end of 1899 you’d now have just £184 to show for it (in real terms) if you had taken the income. But if you had reinvested the income, that £100 would now be worth £28,232.
“The desperate search for income continues to be at the forefront of investors’ minds as UK interest rates remain at a record low,” said Rae. “This has led to many UK investors turning to UK equity income funds as an alternative source of income.”
This is where investment trusts may come into their own. One way in which these differ from other collective funds is that they are allowed to keep 15 per cent of their income in reserve each year so they can maintain payouts during the more fallow periods.
It’s a mechanism that has enabled a number of investment trusts to grow their dividend payments each year for several decades, according to the Association of Investment Companies. They include the City of London trust (which has increased its dividend for 50 successive years), Bankers Trust and Alliance Trust (49 years), Caledonia and F&C, among others.
Tom Munro, director of Falkirk-based Tom Munro Financial Solutions, said: “For me, the solution to falling dividends is undoubtedly investment trusts because of their ability to build revenue reserves in stronger years, facilitating the ‘smoothing’ of payout levels in weaker years.”