Weak corporate earnings and the strength of sterling drags UK dividend growth to a standstill

20th October 2014


UK dividend growth practically ground to a halt in the three months to the end of September as the strong pound, weak corporate earnings and a sluggish global economy took their toll.

According to the latest Capita Asset Services UK Dividend Monitor, which analyses shareholder payouts from British listed firms, headline dividends rose by a mere 0.2% year-on-year to reach £25.5bn, boosted by £1.1bn of special dividends during the period.

Underlying dividends fell by 2.9%, further drawing out the trend of slowing payouts which began three years ago.

The research found that a sharply lower dividend from a newly downsized Vodafone made the biggest dent in the quarterly total – after a world record payout in the first quarter on the sale of its US business – but even if that is taken into account, the third quarter saw the weakest underlying growth in more than two years.

Justin Cooper, chief executive of Shareholder solutions, part of Capita Asset Services said: “We always expected 2014 to be a year of slow growth for dividends, but it’s rapidly turning into a year of no growth. In real terms, underlying dividends paid are going to fall this year.”

The disappointing quarter means that Capita has cut its forecast even further for the year, and it now expects headline dividends to reach £97.1bn, reduced from £98.5bn, sharply higher than 2013 merely due to the £15.9bn Vodafone special payment. It anticipates that underlying dividends will reach £79.3bn, up only 1.7% year on year.

Next year should show an improvement, with sterling likely to be less of a drag. Capita’s first preliminary forecast for 2015, is for headline dividends to be £85.8bn, and underlying payouts to total £83.7bn, up 5.5%.

The impact of sterling’s strength coupled with feeble corporate earnings, have caused the slowdown in dividends this year.

Roughly two fifths of the UK’s annual dividends are declared in US dollars. The pound has now begun to fall against the US dollar, though it remains strong against the euro. The current rate, if it persists, is low enough to provide a boost to dividends next year, but only a small one. Capita estimates it will be £800m to £1bn, and this will kick in from the second quarter.

Big companies are feeling the pain more than smaller ones. FTSE 100 dividends fell 1.1% in the third quarter, compared to a 7.6% increase from the mid cap FTSE 250. This reflects the greater exposure of larger companies to global trends, while smaller ones, which typically have much greater domestic exposure, are benefiting from a more robust UK economy. In fact, at an underlying level, the performance for mid caps has been even stronger, with 16.0% growth.  A buoyant UK consumer pushed dividends from a range of consumer services companies up some 26% year on year in the third quarter, making it the best performing sector.

While 12-month yields on equities have dropped to 3.9% on the back of the weaker dividend outlook, other asset classes have also seen yields fall. 10-year gilt yields are down to 2.45%, property rental yields down to 3.5%, while cash deposits earn just 1.5%.  For an income investor, equities are therefore still providing a superior yield.

Cooper added: “Just as firms have disappointed the stock market with weak earnings, so they have provided a poor showing for dividends too. Much of it is due to global factors, which have overshadowed the strong recovery the UK economy is enjoying. FTSE250 firms are winning the race as a result, with these domestically exposed firms boasting much stronger growth. However, their dividend pool is too small for the big fish among investors, who need to retain significant exposure to the large cap firms which are doing less well at present.”

However, next year should be much better. A lot hinges on the fortunes of the pound and on current trends there is some respite on the horizon. “Most important will be the performance of company earnings. Until those begin to flow through more strongly, it will be hard for dividends to make more rapid progress,” he added.

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