UK equity star Thomas Moore has warned income investors against relying on dividend stalwarts just because the companies have a good history of paying out income.
The manager said there were several firms that have, or may soon have, issues with paying out income. In this category, he cited such companies as oil majors BP and Royal Dutch Shell (pictured), as well as utility stocks such as Centrica and Severn Trent.
Mr Moore said he did not own Shell because he thought it would likely have to cut costs because of the low oil price. He sold out of BP between September and November last year for a similar reason.
The manager said the amount of money Shell spends to get oil out of the ground was now higher than the price of the commodity itself, meaning it would have to make a decision about its dividend soon.
“If you believe the oil price is going back up [Shell] could increase its debt levels for a few years [to cover a dividend] but if the oil price stays low it will have to cut its dividend,” Mr Moore said.
“The main push back [from people who own Shell stock] against that would be that this is a company that has got through the past 25 years so why would it cut its dividend, but you can never say never.”
Mr Moore added that Shell was one of the two most heavily owned stocks by UK equity income managers but in spite of its popularity, this “does make you question to what extent the end clients are aware of the risks, owing [to the fact] that the dividend cover will be falling precipitously”.
In January, Shell outlined wide-ranging spending cuts in response to the low oil price, which has now rebounded to $60 per barrel from its lows of below $50 just a few weeks ago.
Mr Moore said he had sold BP because of what he perceived were “risks to the dividend” from the falling oil price.
“BP may not cut its dividend but I don’t want to be a hostage to fortune,” he said.
Utility stocks Centrica and Severn Trent have recently cut their dividends, which caught many investors out as “lots of income funds have been hiding [in utilities]”, according to Mr Moore.
The manager also warned that so-called bond proxies – defensive companies whose dividends are deemed safe enough to be held just for income purposes, like bonds – were becoming overvalued.
“The key theme in markets is not so much the oil price but more about bond yields,” he said.
“The bond market is pricing in extremely subdued growth, even stagnation, for years to come and so investors are herding towards stocks that are most bond like, such as consumer staples, which are trading on valuations of more than 20x earnings in many cases.”
The manager also said he was not currently interested in the Lloyds Banking Group, which, according to reports last week, was close to returning to the dividend register. Tight banking regulation would likely prevent Lloyds paying out the level of income it wanted to, said Mr Moore.