As companies have sought to protect their cashflow in the wake of the Covid-19 outbreak, dividend pay-outs to shareholders have been widely cut. We bring our dividend forecasts up to date and explore what this means for our charity clients, particularly those who need a regular investment income and consider how severe this income drought might be.
The situation we face today will likely prove to be quite different from previous recessions. Lockdowns prevent populations from consuming (and producing) as normal. Some industries, such as airlines, will see almost no revenues until more normal life resumes. A large number of companies have already cut dividends to protect cashflow or under pressure from the Bank of England and more may follow.
There are a number of ways to judge the likely falls in dividend payouts: futures contracts which allow investors to speculate explicitly on the level of dividend income from several major indices suggest a fall of around 50% in FTSE 100 company dividends since the start of the coronavirus crisis. Another approach would be to look at the dividend yield versus history.
At the end of March, prior to the announcement of most dividend cuts, the UK market had a dividend yield of around 5.5% on a historic basis (based on the last 12 months of payments). This compares to a long run average of around 4.2%. If dividend yields were to fall back to their long-term average, that would represent a fall of 24% on last year's income.
Expectations on dividends vary considerably by industry. Some industries are discounting larger levels of dividend cuts, including materials, energy, financials, consumer discretionary and some consumer staples. This feels intuitively right: materials is a highly cyclical industry, reliant on demand from China, while consumer discretionary shares will be hit as shoppers defer purchases.
The biggest contributors to UK dividends are from the energy and finance sectors, which together comprise nearly 50% of total dividends. Oil prices fell to historic lows as demand has dropped and we believe a recovery in oil prices is required for security of the dividend over the medium term. In the finance sector, we have recently seen the UK banking regulator, the Prudential Regulation Authority (PRA), instruct UK banks to cancel their dividends. Banks are generally well-capitalised, so this action is precautionary. Dividends are likely be restarted when the regulator is satisfied peak danger has passed.
Looking at this picture in aggregate leads us to believe that the UK market could see a cut to dividend income in 2020 of around 40% from pre-crisis expectations. However, charity portfolios will generally fare better because they are not just made up of UK companies. Many will also include global equities, plus fixed income and alternatives such as infrastructure and real estate. They are also actively managed, with more of the portfolio in companies with strong balance sheets and sustainable dividends. This may limit falls to as little as 15% though for safety, clients may want to budget for a drop of up to 30% this year.
Investors reliant on income might consider looking at two UK sectors which we believe are better placed to weather a dividend storm. Healthcare and utilities companies yield around 4% and 5.5% respectively, both little changed from their long-term averages. Income investors should also consider looking globally where they can find companies where payouts may be more sustainable.
Cuts to dividends in the stock market also serve as a reminder of the benefits of diversification in a multi-asset portfolio. While government bonds look expensive on a historic basis, the security of their coupon (and principal) payments is reliable. Furthermore, some alternative assets such as infrastructure can provide relatively high income levels, although some caution is necessary as yields on all assets, including property, come under pressure.
There are ways to mitigate the effects of falling dividends. We recommend engagement with your investment manager for guidance, while being realistic that income generation will be challenging in the coming year and beyond.
Data sourced from Bloomberg/Refinitiv Datastream/Smith & Williamson Investment Management LLP (correct as at May 22nd 2020)
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