Against a gloomy backdrop in the UK, where political and economic uncertainty abounds and assets continue to flow out of UK equities, the UK dividend environment is seemingly thriving – particularly if you take as read, the recent publication of record UK quarterly dividend payouts in the second quarter of the year.
As a UK income fund manager it is vital to look beyond the headline figures, to avoid fixating on individual quarters and to focus on the long-term sustainability of a company’s dividend payments.
The UK market has always had a good culture of paying dividends, in contrast for example, to the US where it is less tax advantageous to do so and where there is more of a focus on raising earnings per share.
But company dividends in any given quarter are volatile and can be influenced in the short term by myriad factors, be it special dividends, or foreign exchange (where a weak sterling can optically help dividends paid in US dollars) – so it is important not to become blinkered by short-term yields.
The growth in dividends in the last quarter can largely be attributed to the mining sector – but these figures should be taken with a pinch of salt. 18 months ago we witnessed mining companies cutting dividends as they struggled with lower commodity prices.
Now their policy is not one of progressive dividends, but rather to pay out a fixed amount of profit after tax. This year profits are healthy, but if commodity prices were to fall, so too could their dividend payments.
I would highlight also, that some of the largest and best-known companies – HSBC, Shell, BP – have failed to grow their dividends over three years.
Nevertheless, UK companies in general are growing their profits, cash flows and therefore their dividends, which presents a fairly healthy outlook for UK companies.
In our view, the interesting investment prospects are those companies which can generate cash as they grow and pay their dividends out of free cash flow, rather than dipping into debt in order to ‘sustain’ the yield.
Consequently, we are inclined to avoid capital intensive industries – those which spend huge sums of money in order to grow or even maintain current levels of profitability drilling for oil, or building a telecommunications network, or building power stations.
Instead, we tend to focus on quality compounders – quality businesses with capital light economics and with the ability to build cash flow, grow their business, and enhance dividends in a sustainable manner over the long term. Examples include software companies, media companies or financial services companies (excluding banks).
An example of such a business is Integrafin, a technology platform servicing financial advisers, which is benefiting from the growth of the UK savings market.
One of its appealing characteristics is that it is a capital lite business – a software company that operates at scale means that it has attractive economics and the real potential to grow its dividends sustainably.