Top market strategists today warned UK investors that some of the largest holdings in the FTSE 100 could face dividend cuts in the second half of the year.
“If you are chasing yields in the stock market at the moment, you should expect an environment where those yields will be cut, at least in the short term,” said Chris Beauchamp, senior market analyst at IG Group, the London-based spread betting trading firm.
He said some of these companies were offering yields way above the average in the index and they were not sustainable.
“If you are company management, and if you see your yield getting higher over the last two weeks, do you keep your dividend or do you take the chance that has been offered to you to cut back dividends and still retain an impressive yield that’s slightly above the broader index?” he questioned.
There are currently 27 FTSE 100 stocks that yield above 4.2%, the current average yield in the index, according to data provided by IG Group. Berkeley Group Holdings (BKG), offers the highest yield across the index at 8.4%, while HSBC Holdings (HSBA) offers a 7.2% yield. Marks and Spencer (MKS), Legal & General Group (LGEN) and Rio Tinto (RIO) are also on the list offering yields above 7%.
While the number of companies in FTSE 100 that yield above 4.2% continues to rise, investors should not assume these big firms have secure dividends, covered by earnings or cash reserves, Beauchamp warned.
“It is worrying that there are a number of names where dividend cover is less than 1%, including Shells, ITV, SSE, even GlaxoSmithKline,” he said, “You have good yields in these companies, but is it going to last till the end of this year? If you have a sustained period of falling stock market prices, you should be prepared to see those yields cut back.”
Morningstar equity analysts agree. Stephen Simko, senior equity analyst at Morningstar said that Royal Dutch Shell (RDSB) will struggle to fund its dividend with organic cash flow in the long term.
GlaxoSmithKline(GSK)’s dividend is also under pressure with the majority of earnings going to fund the dividend, opening up the risk of a dividend cut, Morningstar analyst Damien Conover said.
However, there are some firms with a very strong dividend cover that Beaucoup is confident in, including Associated British Foods (ABF) and InterContinental Hotels Group (IHG), having more than 4% dividend cover, according to IG’s data.
Continued Popularity Among Dividend Stocks
Despite a potential dividend cuts in stocks, Beauchamp believes investors have to invest in stocks in an environment where government bonds continue to fall into negative yield territory and low interest rates in saving accounts.
“Would you want to go on being paid nothing? Or would you at least want to secure companies that are providing you a yield, even if capital returns continue to be weak?” he said, stating that as uncertainty continues in the UK at the moment, retail investors will undoubtedly continue to look towards dividend-paying stocks, in the same way they have been doing over the last couple of years.
Looking ahead, Beauchamp continues to favour firms with international diversification which benefit from a weaker UK currency, including companies in the pharmaceuticals, tobacco and drinks sectors.
