Staying vigilant amid Brexit uncertainty

The story of Vodafone illustrates a key weakness in the UK equity income market: investors are often reliant on a handful of big payers. With other cuts on the cards, generating income from UK stocks could yet prove trickier than expected. Marks & Spencer also announced a dividend cut this year, and others have signalled their payouts are unlikely to increase in the near future.

Flutter (formerly Paddy Power Betfair) has confirmed an unchanged annual payment for 2018, rather than a higher one. Similarly, Standard Life Aberdeen is targeting an unchanged payout level after a series of increases, while Aviva has dialled back expectations around its own rate of future dividend growth.

Meanwhile, SSE will reduce its dividend next year and BT recently suggested it could cut its payout in future to fund the expansion of its UK fibre broadband network. Other names are also causing concern: OLIM noted in its mid-year report that Centrica’s earnings were under “great pressure”. That said, dividend payers such as HSBC have seen business conditions improve.

Patrick Harrington, a director at OLIM, notes: “Doubts still hang over the dividends of some of the market’s largest income stocks, but the companies involved are most likely to maintain payments at the expense of their balance sheets, at least over the short term. However, this is not a process that can continue indefinitely.”

Rocks and hard places

While this is unwelcome news for clients with decumulation needs, UK equity income remains a core part of many portfolios focused on yield. A combination of investor nerves and loose monetary policy have sent bond yields tumbling this year, while other equity markets yield less and are even more vulnerable to currency effects than UK shares. And as discussed in this month’s cover story (see page 34), the likes of alternative assets such as infrastructure offer good yields but can come with their own problems.

Investors who stick by UK shares will have to be selective, whether they are buying equities or using funds focused on this space. This can mean exercising caution when it comes to stocks with particularly high yields, or at least offsetting this risk with exposure to steady, lower-yielding names.

Mr Murphy notes: “There’s a high headline yield [in the market], but as we saw with Vodafone, companies are often very high-yielding for a reason. You have to have the balance between some of the high-yielders and those that can grow their dividend.”

As Table 1 shows, some yield forecasts for 2019 remain eye-wateringly high. Persimmon’s stands at 12 per cent, with three other payout levels also reaching into double figures. Dividend cover, inevitably, varies.

Table 1: Yield forecasts and dividend cover for 2019