Vodafone Group Plc (LON:VOD) and Marks & Spencer Group PLC (LON:MKS) have both bitten the bullet and given their dividends haircuts of varying severity recently, so could this give other ‘dividend slaves’ confidence to follow suit?
This topic has become increasingly hot for many large companies in recent months, with investors and analysts at odds over whether reducing the payout is the right thing to do.
Management at some of these corporate giants may feel they are fettered to a long-time dividend policy, paying out cash to shareholders at a level they think is unsustainable when it may be better used to ramp up investment in the company. Sometimes companies are even borrowing to pay dividends due to a lack of cash flow.
On the other side of the coin, shareholders - from retail yield hunters up to huge income funds - are very fond of some of the 6%, 7%, 8% even up to 12% dividend yields currently on offer in the FTSE 350, with Vodafone topping 9% before its cut.
“The market is highlighting through the very high yields that some companies are susceptible to dividend cuts,” says Laith Khalaf, senior analyst at Hargreaves Lansdown.
|Company||Forecast yield (%)|
|Galliford Try plc||12.0|
|Stobart Group Ltd||11.9|
|Taylor Wimpey PLC||10.3|
|Royal Mail Group PLC||10.1|
|Bovis Homes Group PLC||9.8|
|BHP Group PLC||9.6|
|Imperial Brands PLC||9.5|
|NewRiver REIT plc||9.5|
|Direct Line Insurance Group PLC||9.2|
|Crest Nicholson Holdings Ltd 9.2||9.2|
|IG Group Holdings PLC||8.7|
|Standard Life Aberdeen PLC||8.4|
|Card Factory PLC||8.2|
|(Table data from AJ Bell)|
But Khalaf says that he does not think Vodafone’s move is likely to be the first domino in the chain.
“It doesn’t work that way, particularly as other companies are in different sectors and each one has its own financial situation. They could cut but they will be taking into account different pressures and will be consulting their own key stakeholders.”
While income fund managers will be pushing hard for dividends to be maintained but even though though these payments are their lifeblood, Khalaf says: “All investors would take into account the financial stability of the company and recognise if it is paying too much out as dividends and doesn't have enough to cover other obligations such as debt or operational expenditure that it will get into a bit of a pickle. There’s a balance that needs to be made.”
Vodafone shares were pretty out of favour, as a yield over 9% indicated, and Khalaf is not sure they will become firm favourites quite yet. The dividend cut “looks prudent” but he said the “big dial-mover for the company is making sure the acquisition from Liberty Global goes well.”
Centrica susceptible, BT too
He sees Centrica as one of those susceptible, but not BP and Shell, as they managed to cope with the oil price at much lower levels and still maintained their dividends.
Of BT he says, “possibly”.
All eyes were on the telecoms group ahead of its results last week, which were preceded by the sort of will-they-won’t-they coverage normally associated with popular TV programmes, spiced up by reports of a boardroom split.
In the end, the BT kept its full-year dividend unchanged for now and, with a need to invest billions in its pensions scheme and investing in laying ultrafast broadband cables around the country, it could merely be kicking the can down the road.
Michael Kempe, whose Link Market Services published the Dividend Monitor report every quarter, disagreed as he felt Vodafone’s cut “may give BT cover to follow suit”.
“BT made a very small reduction in its last interim payout but made that up with the final one for the year. So it hasn’t yet taken the plunge, but it may only be a matter of time,” Kempe said.
Recalling BT’s prior form for dividend cuts in 2002 and in 2010, Russ Mould, investment director at AJ Bell, has doubts: “The danger is that the margin of safety offered by BT’s cash flow is shrinking, even as it does a good job of reining in costs, and the telco is hemmed in by multiple competitors on one side, price-sensitive consumers on another and the regulator on another.”
High yield checks for investors
Mould offers investors four checks to help them decide whether a chief executive is a slave to the dividend or whether they could take the bull by the horns and cut the payout.
These four measures are dividend cover by earnings, dividend cover by free cash flow, interest cover and net debt, and finally, the size of the pension deficit or surplus.
Dividend cover, which is calculated by dividing forecast earnings per share by the forecast dividend per share, should ideally exceed a ratio of 2.0.
“Anything below two needs to be watched and a ratio under 1.0 suggests danger, unless the firm is a real estate investment trust,” he says.
Ahead of its announcement, Vodafone’s dividend cover of 0.76 was seen as less than ideal, while its net debt was also a worry, Vodafone reported net debt of €27bn but it is about to take on another €18.4bn thanks to the European cable TV acquisition from Liberty Global.
Watching SSE, Persimmon, Evraz and TUI
SSE, which announces its results next week, cut its payout last year and Mould is one of many eying a repeat in 2019.
“The picture at the utility is muddied by the failure of its plan to merge its retail energy supply operation with that of npower and its proposal to break itself up, with the renewables and power generation operations paying a fat dividend and the retail supply business possibly offering nothing at all.
"The good news for investors is that a cut to around 80p from 97.6p is looks at least partly factored in by the share price falls of the past year.”
He said there was a danger that board decides it has room to cut the dividend deeper still, as the yield still looks “pretty plump” at around the 7% mark.
Mould added: “Forecast earnings cover for the reduced dividend of 1.25 times is acceptable for a utility and although the firm has a lot of debt and high gearing ratio you can make allowances on this count, too, given that demand should be relatively steady. However, any further regulatory pressure could be a concern to income seekers.”
Other FTSE giants with whopping yields include builders Persimmon PLC (LON:PSN) and Taylor Wimpey PLC (LON:TW.) and Russian steel basher Evraz plc (LON:EVR), all topping 10%, as well as TUI AG (LON:TUI), Imperial Brands PLC (LON:IMB), British American Tobacco PLC (LON:BATS), Direct Line Insurance Group PLC (LON:DLG), Aviva PLC (LON:AV.) and Admiral Group PLC (LON:ADM).
|FTSE 100's top yields||Dividend yield||Earnings cover (EPS/DPS)|
|Taylor Wimpey||10.4%||1.13 x|
|Imperial Brands||9.6%||1.38 x|
|Direct Line||8.8%||1.05 x|
|Standard Life Aberdeen||8.3%||1.00 x|
|Barratt Developments||7.4%||1.54 x|
|British American Tobacco||7.2%||1.50 x|
|Phoenix Group||6.9%||1.02 x|
|Admiral Group||6.6%||0.98 x|
|Legal and General||6.4%||1.77 x|
|(Table data from AJ Bell)|
Grace Jones' song Slave to the Rhythm might well have been about the pressure of a progressive dividend policy: 'Build on up, don't break the chain; Sparks will fly when the whistle blows'.