In 2019, UK banks paid out £15.6 billion in dividends, 14% of the entire UK dividend pool. This year the mining, oil and gas and travel sectors have been amongst the worst hit. What does this mean for investors?
Published on 02 Apr 20203 minute read
Written by Jason Hollands
While the yields displayed on many equity fund factsheets are seemingly very attractive at the moment (in the case of many UK equity income funds over 5%), it is really important to flag that in the current environment investors should not assume that these are in any way indicative of future income pay-outs in the short to medium term. They are not.
The yield data displayed on fund factsheets is calculated on the basis of income generated by the portfolio as a percentage of the current value. Yields have therefore risen as share prices have fallen. But the sustainability of past pay-outs – which last year were at a record level of £110.5 billion boosted by £12 billion of special dividends and were already forecast to fall in 2020 before the coronavirus pandemic – is in grave doubt in the current environment. We expect to enter a recession and there is considerable uncertainty around company earnings.
A number of UK business have already announced dividend cuts or suspended them and all the major UK banks, responding to a request from the UK Prudential Regulatory Authority, have just collectively agreed not to make any dividend or interim dividend pay-outs in 2020 nor undertake share buybacks. Instead, they will preserve capital to ensure they support businesses and borrowers through the current period of economic stress.
This has significant implications: in 2019, UK banks paid out £15.6 billion in dividends which represented 14% of the entire UK dividend pool. More companies will almost certainly follow with dividend cuts and cancellations.
Dividend growth last year was powered by the mining sector and the banks and it was also particularly strong in the tourism and travel sectors.
The mining, oil and gas and travel sectors have been amongst the worst hit this year.
It is worth pointing out that the overall UK dividend pool is highly concentrated around a small number of mega-stocks, with five companies accounting for 34% of all pay outs last year. These include oil giants Royal Dutch Shell and BP, whose values have halved as oil prices have tumbled, mining stock Rio Tinto and HSBC Bank who have ceased dividends for 2020.
Dividend pay-outs are extremely vulnerable in the short term. This will clearly impact those retirees with pensions in drawdown as well as those who top-up income from annuities, defined benefit pensions and the state pension with income from ISAs and shares. This income squeeze will ultimately be temporary and should pass when the pandemic abates and the economy comes through the crisis. Pay-out ratios should normalise in 2021, though some companies may well take the opportunity to lower the bar on target pay-out ratios which have been high.
In the meantime, those reliant on their savings and investments face the prospect of belt-tightening with dividend cuts and record low interest rates the order of the day. If at all possible, they should avoid eating into capital to sustain withdrawals from their pensions while share prices are so low, because this risks draining their pensions too rapidly and impairing the recovery potential.
Those with rainy day cash savings should therefore consider using these to top-up reduced investment or consider pausing or reducing the levels of their withdrawals to reflect a possible reduction in day-to-day spending during the lockdown. For those who do need continue taking money from their pensions, it might be worth considering doing so on a monthly basis rather than taking larger, occasional lump sums in the current environment when share prices are low.
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