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While UK dividends hit record £19.7bn in first quarter, some FTSE 100 companies could be headed for cuts

Basic measures like dividend cover suggest a number of blue chips might be struggling to maintain their payouts at current levels
Dividend cut
British gas owner Centrica only has a dividend cover of 0.9, indicating that it currently needs to borrow money to maintain its payments

Dividends paid out in the UK hit a record high of £19.7bn in the first quarter but beneath a healthy looking headline, the picture might not be so bright.

Much of the record total was attributed to a £2.6bn special dividend from FTSE 100 miner BHP Group PLC (LON:BHP), which delivered the bumper sum from proceeds of the sale of its US shale oil interests.

Basic measures also suggest a number of blue chips might be struggling to maintain their payouts at current levels. 

Dividend cover is a broad brush and simple measurement that essentially indicates the level of earnings a company has to generate in order to maintain payments to shareholders.

A cover level of 1 suggests all the earnings are being paid out as dividends, but with the need of capex, investment in the business and so on, most investors consider a comfortable dividend cover to be at or above 1.5.

By this metric, British Gas owner Centrica PLC (LON:CNA), which has a dividend cover of 0.9, is only covering 90% of its dividend and needs to borrow money in order to maintain its payments.

While it has been a favoured stock of income investors for years, Centrica has already been pegged for an imminent dividend cut by analysts at JP Morgan after it warned in February that an energy bill price cap, due to come into force in April, would hit its 2019 financial performance.

READ: British Gas owner Centrica to miss earnings forecasts and dividend cut imminent, JP Morgan predicts

"For some time we have argued that the introduction of price regulation in the UK would adversely impact competition leading to compressed market pricing and therefore lower churn," JP Morgan said in April.

The prospect of a dividend cut is a particularly sore spot for utility stocks such as Centrica, which typically rely on fat dividends to attract investment as their growth prospects tend to be constrained by government regulation.

Telecom heavyweights give off bad signals

Aside from Centrica, two telecoms heavyweights, Vodafone Group PLC (LON:VOD) and BT Group PLC (LON:BT.A), are also on the list to get their scissors out.

Vodafone, which with a dividend cover of 0.8 is already considered a risk, is expecting an earnings hit in 2019 from the adoption of new accounting practices, which means it has to exclude UK handset financing from the numbers.

A €4bn convertible loan issue in March to finance the acquisition of assets in Germany, the Czech Republic, Hungary and Romania, from rival Liberty Global hasn’t helped as it adds more potential debt to the balance sheet as the two tranches will mature no later than March 2021 and March 2022.

READ: Vodafone rocked with double downgrade to ‘underperform’ by RBC citing “unsustainable” dividend

The sustainability of the company’s dividend has already been questioned by analysts at RBC, who said in a January note that the group’s €4.1bn total dividend payout for the fiscal year ended 31 March 2019 would be “unsustainable beyond that”.

The Canadian bank has also said that the company’s leverage (debt) was “too high, especially at this point in the economic cycle”.

BT is a more interesting case, as on the face of it, a dividend cover at 1.8 is not as bad as either Centrica or Vodafone, and is also above the commonly held ‘safe’ threshold of 1.5.

However, the company’s shares have tanked over the last two years in the wake of an accounting scandal at its Italian division, as well as a change at the top after chief executive (CEO) Gavin Patterson was replaced by ex-Worldpay Inc (LON:WPY) CEO Philip Jansen in February, who some analysts think could sacrifice some of the divi in order to help fund a turnaround.

In a note in February, investment bank Berenberg said that in order to drive growth and support the company’s pension deficit, Jansen would be “right for the long-term” to prioritise investment over dividend maintenance, although it also warned that investors “will not like it”.

READ: Berenberg thinks new BT boss may cut telecoms giant’s dividend

Analysts pointed out that BT’s free cash flow is £2.5bn, which is £1bn more than the cost of paying out its dividend.

However, from this £1bn, the group would need to “support the pension deficit, buy spectrum, buy back employee share options to prevent dilution, and fund restructuring”, all of which would shrink headroom and pile pressure on the payout.

The struggles of BT and Vodafone mirrored the sub-par performance of the sector as a whole in the record-breaking dividend first quarter, with Telecoms divis falling 2% year-on-year (YOY) on an underlying basis to £1.6bn.

Construction and retail also disappoint

Across the rest of the market, building materials and construction firms bucked the positive trend in the first quarter, with dividend payments falling 5% YOY as several blue-chip housebuilders including Persimmon PLC (LON:PSM) were left facing uncertainty over their profits amid reports that the government could end the Help to Buy scheme, which has encouraged a boom in home construction.

Food and general retailing was another sector to report a decline, with payouts slumping 23% to £546mln as companies such as Marks and Spencer Group PLC (LON:MKS) held their dividends flat while Debenhams PLC (LON:DEB) cancelled it altogether before collapsing into administration.

By contrast, the two highest-paying sectors were oil and pharmaceuticals, which were helped in the first instance by the rising oil price and currencies in the second.

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