Fund manager view: how Brexit is reshaping the outlook for UK dividends
As if the current low-yield environment had not provided an ample enough challenge, Brexit is squeezing the UK’s income investors even further. Since the global financial crisis, savers and investors have been battling record low bond yields and dismal returns on cash, and now they face a further round of interest rate cuts and quantitative easing.
Set against this challenging background, investors will be increasingly pushed towards UK equities in the hunt for yield. Compared with gilts and other traditional income investments, UK equities offer relatively attractive yields in dividend payments.
Currency tailwind delivers dividend windfall
The lack of a formal timeframe for exiting the European Union will only lead to further uncertainty and increased exchange rate volatility in the near to medium term. The collapse of sterling against the US dollar to a 31 year low post Brexit had provided investors with a windfall to the tune of £4.3bn. The biggest beneficiaries will be multinational companies that are large exporters including the oil majors BP and Shell and healthcare giants GlaxoSmithKline and AstraZeneca.
There will also be increased pricing pressure on companies which import raw materials from overseas – particularly among domestically focused small and mid-sized companies such as UK housebuilders. The sector has been sold off with concerns over the prospect of rising labour costs and building materials. Although, it should be noted there are plenty of small and mid-cap UK companies with large overseas earnings such as Victrex, a specialist chemicals manufacturer, that has over 95% of overseas earnings, whilst Porvair, a specialist filtration producer, has over 80% of non-UK earnings.
Record pay outs for investors
The second quarter provided investors with a record pay out of £28.8bn (up 8%), surpassing the previous record of the first quarter of 2014. A total of 22 companies paid a special dividend in Q2 and this included large pay outs by companies such as Intercontinental Hotels, GlaxoSmithKline and ITV. Although investors should welcome the windfall, they should note that dividends excluding specials fell by 3% year-on-year, despite a £960m exchange rate gain via a weaker sterling pre-Brexit.
Financials lead the way
Financial companies led the way in Q2 despite the cancellation of Standard Chartered’s £900mn pay out. Notable contributors include Lloyds Bank which returned to the dividend list and life insurers. Miners continue to struggle with payments halving year on year. Oil companies which were under great pressure at the start of the year have been buoyed by a rise in both the oil price and the US dollar. Healthcare remains a bright spot, with companies like GlaxoSmithKline and AstraZeneca offering yields of 4-5%, buoyed by a large US dollar exposure.
Dividend cover remains a concern
The landscape for income investors remains challenging, despite short-to-medium term tailwinds. Investors will have to be wary of concentration risk, with nearly two thirds of the total dividend payments made by the top 15 companies. The top five dividend payers made up nearly 40% of the pay out in the quarter, the highest since 2011.
UK companies are struggling to grow profits in a highly uncertain macroeconomic environment. Although dividends have held up, the level of dividend cover remains a source of concern. The prospects of companies delivering dividend growth look increasingly challenged in the medium to long-term. Investors should look for investment managers who have a well-established track record in picking companies that are able to deliver sustainable growing dividends, regardless of the wider economic climate.
Ketan Patel is a portfolio manager at EdenTree Investment Management