AJ Bell  

FTSE 100 dividends in the danger zone

FTSE 100 dividends in the danger zone

The level of dividend cover among the FTSE 100 is likely to be less in 2018 than it was prior to the financial crisis, according to data from stockbroker AJ Bell.

A fully covered dividend is one which is paid from the cashflow generated by the underlying operations of the business in the period.

Companies that do not generate the cash to pay the dividend can use reserves, or debt, to make up the shortfall.

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Typically the market regards companies with cashflows of twice the anticipated level of the dividend as having fully covered the dividend.

Data from AJ Bell indicates that FTSE 100 dividend cover going into 2018 is 1.63 times, which it regards as the 'danger zone', while the 10 largest companies in the FTSE 100 have dividend cover of just 1.36 times, yet those stocks are currently responsible for 55 per cent of the dividend income in the FTSE 100.

Russ Mould, investment director at AJ Bell, said: "The issue of skinny dividend cover refuses to go away. Earnings cover for dividends remains much thinner than ideal at 1.63 for 2018 and there has been little real improvement here in 2017.

"Ideally earnings cover needs to be around the 2.0 level to offer a margin of safety to dividend payments, should there be a sudden and unexpected downturn in trading at a specific company, or indeed the UK and global economies as a whole.

"Pearson and Provident Financial are both examples of what can happen in the event of a profits stumble under such circumstances, as both had been offering apparently juicy yields but with skinny earnings cover.  

"Indeed, some of the companies with the juiciest looking dividend yields have dividend cover that looks particularly malnourished at 1.37."

The FTSE 100 stock with the lowest level of dividend cover going into 2018 is energy company Centrica.

Centrica is also the company in the blue-chip index with the largest forecast dividend yield in 2018, at 8 per cent.

Worries about the sustainability of Centrica's dividend has prompted Simon Gergel, who runs the £714m Merchants investment trust to sell all of his shares in the company.

Mr Gergel said: "Centrica had a profit warning, citing competitive pressures and lower margins in both its UK retail and its US businesses.

"Although the company has committed to this year's dividend, the cover is now running quite thin.

"More fundamentally, we have reassessed our level of conviction in the investment case. There should be significant scale advantages in energy supply, coming from operational efficiency and the use of a strong balance sheet to hedge commodity costs.

"However, a combination of government policies that favour smaller suppliers, intense media encouraging switching and political pressure for price caps, have undermined the competitive advantages of scale.

"We have therefore sold the position, despite a low headline valuation. We reinvested part of the proceeds into SSE, which is also cheaply rated due to political uncertainty, but importantly, earns the bulk of returns from regulated assets rather than competitive commodity markets."