UK Dividends in "Good Shape" Despite Brexit Uncertainty

Henderson's Laura Foll, manager of Lowland Investment Company, is bullish on the income picture for UK plc despite political uncertainty

David Brenchley 21 February, 2019 | 2:27PM
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dividends, UK dividends, FTSE 100, FTSE All-Share, dividend yield, sterling, UK stock market, Brexit

UK company dividends are safer than they have been for a number of years, according to Janus Henderson’s Laura Foll. She says the high-yielding UK stock market is looking particularly attractive for income seekers.

The FTSE All-Share currently yields 4.6% - a pretty good starting point. Estimates for dividend growth this year stand at around 8%. “That makes the market look pretty attractive,” Foll ventures.

That 8% growth figure “feels quite nailed down”, adds the co-manager of the Morningstar Silver Rated Lowland Investment Company (LWI). And we’ve already seen recently Royal Bank of Scotland (RBS) announce a huge special dividend and Lloyds (LLOY) ramp up its payout by 5%.

“If you’d asked me a few years ago about risk in dividends in the UK, I would have said there was more dividend risk in the market then than there is now,” Foll explains.

Around five years ago, during the dramatic collapse of the oil price, the likes of Shell (RDSB) and BP (BP.) bottomed out with yields of 8%, as did healthcare firm GlaxoSmithKline (GSK). That kind of number generally implies worries over the sustainability of the dividend.

And there were plenty of question marks around back then, not least whether the oil majors could keep paying big dividends with the oil price as low as $30. Now, Foll thinks those question marks have been “largely resolved”.

She adds: “Shell and BP can very comfortably cover their dividends, even at $50 oil. Glaxo’s a bigger question, but it’s slightly answered that by saying it’s going to split up in a few years’ time into a pharma and consumer company.

“There’s a natural point at which to ask the question of what’s the right dividend for them to pay, but it’s very logical for them to split up.”

Now, clearly there are some fears over individual company dividends – Vodafone’s (VOD) 9% yield, for instance, suggests its payment is in trouble.

No-Deal Brexit Could be Positive for Dividends

One potential fly in the ointment is the spectre of a no-deal Brexit, the likelihood of which seems to be rising and is very much putting many investors off the UK market despite attractive valuations. But Foll is relatively unfazed. In fact, she says a hard or no-deal Brexit would be better for dividends specifically than a soft Brexit or remain.

It’s a well-known fact that around 75% of UK plc’s earnings are derived from overseas. Therefore, a hard Brexit-related fall in sterling would boost the majority of earnings.

“So, a more difficult dividend scenario would be sterling recovering to $1.50. In that scenario, you basically get to flat dividend growth rather than 8%,” Foll notes. Clearly, though, a perceived good Brexit outcome would “be very positive for UK equities”, so there would be no complaints if dividends did not grow.

And Foll says Lowland’s dividend does tend to be derived from its small and mid-cap holdings, which tend to be more domestically focused. But she says the fundamentals of these stocks remain strong: “Lowland’s 3.9% yield is historically high and, again would imply there’s a big question mark about the sustainability of those dividends and I think that’s quite unfair.

“What you’re seeing from a lot of the smaller and medium-sized companies is that cash generation is still very strong, they’re still seeing good levels of earnings growth and the level of dividend growth you’re getting at that end is really quite attractive.”

Two examples Foll picks out here are AIM-quoted Redde (REDD), a services provider to the car insurance industry, and FTSE Small Cap-listed Ten Entertainment (TEG), a provider of bowling alleys. The starting yield for this duo is around 7% and 6% respectively, with 10% annual dividend growth.

“At the small and medium-sized company end there’s this perception that they tend to be lower yield and faster-growing. That is right, but there’s also those that offer attractive yields, as well.”

Shell is the largest single contributor of dividends for the trust, but the position has been reduced significantly, from 8% weight to around 6%, over the past couple of months as the managers look to recycle profits into other areas that had been sold off in the final three months of 2018.

Topping Up UK Domestic Exposure

Foll says Lowland was a “heavy net buyer” in December and early January, taking advantage of volatility, though her and co-manager James Henderson have stopped buying more recently after a strong start to 2019.

Those additions were generally domestic firms. “What happened after the 2016 referendum was UK domestic companies started trading at a valuation discount and that valuation discount has never closed; if anything, it’s widened.”

That discount, on a price/earnings basis, is around 25% compared with the broader market. “If you looked back historically, they would have traded in line with the market, so that is an anomaly that’s opened up since the referendum.”

Water utility Severn Trent (SVT) has quickly become a large position in the portfolio, at around 2% of the fund.

Clearly, there’s a question over a potential Jeremy Corbyn Government and how that will impact the sector. But Foll says Severn Trent is a “very good quality water company” that is very well managed.

Because of that uncertainty, it’s also cheap, she argues. “When we were buying it, it was already barely at a premium to regulated asset base, which is historically a real anomaly. Year-to-date it’s done well and is at a 10% premium but that’s still lower than where it’s been historically.

“It’s also lower than the returns would justify, so there already is definitely a discount on these companies because of the overhang. I do think it’s already to a degree being priced in.”

Lowland has been out of the housebuilding sector since 2015, so December’s purchase of Taylor Wimpey (TW.) is “a controversial one for us”. Around that time, they got a bit too expensive, so the trust sold out of the sector.

However, Taylor Wimpey, having peaked at around 2-2.5 times book value three years ago, had slipped to around 1.25 times in December. At that point, it was added to Lowland’s portfolio. Since then, it’s up almost a third, so profits have already been taken, but a holding remains.

Other additions include real estate investment trust Land Securities (LAND), Greene King (GNK) and Dunelm (DNLM).

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David Brenchley

David Brenchley  is a Reporter for

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