Quality boost for UK equity income ETFs as dividend cover doubles

Jul 5th, 2018 | By | Category: Equities

Dividend cover for the UK’s 350 largest listed companies more than doubled in the past year, according to research by The Share Centre. The research demonstrates the enhanced dependability of dividends from UK-listed stocks (for now, at least) and should boost the appeal of UK equity income ETFs to yield-seeking investors.

Helal Miah, research investment analyst from The Share Centre

Helal Miah, research investment analyst from The Share Centre.

Dividend cover is the ratio of a company’s net profits to the total sum allotted in dividends to ordinary shareholders. A higher ratio suggests dividends are more affordable and sustainable for companies.

The dividend cover ratio for the UK’s largest 350 firms has rocketed from 0.8x to 1.8x over the past 12 months as company profits recovered among the top 350, rising far faster than dividends paid to shareholders.

Profits reported by the UK’s top 350 listed firms over the last year shot up by a staggering 157%, rising from £67.2bn to £172.7bn. Dividends paid on those profits have increased at a much steadier rate, climbing by 10% to £93.6bn.

The dividend cover figure is the ratio’s highest level in three years, and marks a significant improvement on the previous two years, which have seen dividends exceed profits.

“Rocketing profits among UK plc has driven a rapid recovery in dividend cover, much to the relief of income investors, who had justifiably begun to worry that their dividends might not be sustainable.”
Helal Miah, research investment analyst from The Share Centre

Helal Miah, research investment analyst from The Share Centre, said, “Rocketing profits among UK plc has driven a rapid recovery in dividend cover, much to the relief of income investors, who had justifiably begun to worry that their dividends might not be sustainable. Companies can only afford to pay more in dividends than they make in profits for a very short time. Dividend cuts follow quite quickly.”

Seventeen out of 19 sectors saw their dividend cover ratio improve. Mining companies experienced the fastest rise, from 0.4x to 3.1x, which The Share Centre credits to a sharp recovery in commodity prices coupled with the profit-boosting effect of steep cost-cutting.

In contrast, property companies saw a large fall in dividend cover, down from 3.5x to 1.9x, as their profits more than halved on the back of a slowing property market. Utility companies also saw a fall from 1.5x to 0.7x. The sector’s profits fell by 22%, largely driven by a weak performance from Centrica.

In terms of market cap, dividend cover in the top 100 exceeded that of companies in the mid-cap 250 for the first time in three years.

“The improving global economy has put extra wind in the sails of the UK’s multinational large-caps, who also benefited from positive exchange-rate effects last year,” said Miah. “The mining industry is a case in point, with improving global demand boosting commodity prices and profitability.”

In the top 100, dividend cover increased to 1.9x from 0.7x a year ago. Profits increased by 181%, with big improvements from the likes of Shell, BHP Billiton, HSBC and BAT, while dividends rose by a far gentler 11%. Among mid-caps, cover climbed to 1.7x, following slower profit growth.

FEATURED ETFs

iShares UK Dividend UCITS ETF
Tracks the FTSE UK Dividend+ Index

WisdomTree UK Equity Income UCITS ETF
Tracks the WisdomTree UK Equity Income Index

SPDR S&P UK Dividend Aristocrats UCITS ETF
Tracks the S&P UK High Yield Dividend Aristocrats Index

BMO MSCI UK Income Leaders UCITS ETF
Tracks the MSCI UK Select Quality Yield Index

While the surge in dividend cover will be welcomed by investors, Miah warns there may be headwinds ahead.

“The slowing UK economy will challenge the profitability of domestically-focussed companies,” he said. “We are already seeing a slowdown in the housing market and consumer spending, which likely means pain for companies dependent on these areas. A weaker domestic performance may affect the sustainability of dividends in the 250, meaning large caps are set to outperform once more.”

There are a number of ETFs for investors looking to gain exposure to high-dividend-paying UK equities.

The largest is the iShares UK Dividend UCITS ETF (IUKD LN) which has assets under management of £700 million and a total expense ratio (TER) of 0.40%. IUKD tracks the FTSE UK Dividend+ Index, composed of the 50 UK stocks with the highest dividend yield in the FTSE 350. It currently has a distribution yield of 5.2%.

Alternatively, the WisdomTree UK Equity Income UCITS ETF (WUKD LN) provides exposure to the top 33% of UK stocks from the WisdomTree International Equity Index ranked by dividend yield. The fund a TER of 0.29% and a distribution yield of 4.7%; however, it is much smaller than IUKD with assets of just £5m.

For investors who are still concerned about the sustainability of future dividend payments, there are several ETFs that have been designed with that in mind.

The SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV LN) tracks the S&P UK High Yield Dividend Aristocrats Index which references the performance of the 30 highest dividend-yielding UK stocks that have paid increasing or stable dividends over the previous ten years. UKDV has a distribution yield of 4.6%, AUM of £90m, and a TER of 0.30%.

The BMO MSCI UK Income Leaders UCITS ETF (ZILK LN) takes a different approach to build a portfolio of stocks with sustainable dividends. It tracks the MSCI UK Select Quality Yield Index which includes the performance of, currently, 26 high dividend-yielding stocks from the MSCI UK Index that have been screened for financial ‘quality’. Quality is calculated using fundamental variables such as Return on Equity, Earnings Variability and Debt to Equity. The fund has AUM of £37m, a TER of 0.35%, and a distribution yield of 4.8%.

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