Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
NO equity income investor needs reminding what a challenging year 2020 was. In a seminal moment last March, the Bank of England directed banks to cancel their dividends, a step that would have been considered unthinkable before the 2008 financial crisis. Meanwhile, Royal Dutch Shell, reeling in the wake of Brent crude plumbing depths below US$30 per barrel, cut its dividend for the first time since World War II.
Many other UK companies followed that lead in an unprecedented wave of dividend cuts or suspensions. With great uncertainty surrounding how the Covid-19 pandemic would evolve and jobs at risk, it seemed to make sense for companies to take the opportunity to strengthen their capital reserves and not to continue transferring wealth to investors.
That perilous episode for income investors appears to be coming to a close now, with 2021 promising to be the year of a great dividend recovery. Since the turn of the year, FTSE 100 firms have been returning to the dividend list apace. The FTSE 100 already yields 3%, not far short of the 4% last seen in 20191. This figure can be expected to rise further from here.
The positive side to the dip then recovery in shareholder payouts is that dividend cover – the ratio of earnings to dividends – has strengthened. More companies are proposing to pay dividends they can easily meet, now that some previously stretched payers have restarted their payouts from a lower, but more sustainable base. Dividend cover of 1.5 times or higher is now commonplace2.
Banks look to be in a strong position to increase their dividends – albeit from a significantly lower base than in 2019 – as they benefit from the twin benefits of a strengthening economy and the prospect of widening lending margins. House prices have continued to rise and the credit quality of bank customers is good, owing, in large part, to a considerable rise in household savings over the past year.
Barclays highlighted a dramatically improved position this week, with the release of credit impairment provisions amounting to £742 million in the second quarter. That helped lift pre-tax profits to £5 billion, from £1.3 billion in the same period last year. The bank doubled its dividend to 2p after paying a full-year dividend of 1p in April, its first since the pandemic struck3.
Lloyds and NatWest followed suit, both adding back bad loan provisions and announcing raised dividends. NatWest said it now aims to distribute a minimum of £1 billion per annum from 2021 to 2023, via a combination of ordinary and special dividends4.
Mining companies have been benefitting from a strong demand for commodities including iron ore and copper, as trillions of dollars have been poured into recovery packages. Years of production and cost cuts throughout the sector mean the UK’s low cost mining giants – Rio Tinto, BHP and, to a lesser extent, Anglo American – have been in prime position to benefit from a rapid change of scene.
Rio Tinto, the world’s largest producer of iron ore, reported underlying earnings in the first half of the year of £12.2 billion, up 156% on 2020. The company’s total interim payout amounting to £9.1 billion (376 US cents) – plus a special dividend of £3 billion (185 US cents) – will be more than the company distributed in the whole of 20205. Rio Tinto is on course to be the FTSE 100’s largest dividend payer this year.
Meanwhile, Shell topped the oil sector’s good news leader board, unexpectedly raising its quarterly dividend by 38% from the previous three month period, to 24 cents per share. Like its peers, Shell has benefitted from a strong and sustained rise in oil prices, from a low point below US$30 in 2020 to more than US$70 in the second quarter of this year.
Despite the continued depressed consumption of aviation fuel, the demand for oil worldwide is back close to pre-pandemic levels. Shell’s adjusted earnings increased to US$5.5 billion in the second quarter, up from US$638 million a year earlier6.
Other UK companies raising their dividends last week included BAE Systems. ITV and Weir Group resumed payments. Results this coming week from HSBC – once the world’s largest dividend payer – are widely expected to be accompanied by news that the bank’s dividend has been increased.
The good news on dividends clearly has further to run. Shell, for example, said earlier this month it will raise its distributions to shareholders via dividends or share buybacks so that they equal to between 20% and 30% of its operating cash flows starting from its (this week’s) second quarter earnings announcement7.
Meanwhile, mining companies have strong balance sheets these days, lessening the need to further cuts costs through mergers and acquisitions. That leaves more than ever before to hand back to shareholders.
Undoubtedly, there remain other issues investors in the big dividend payers will have to face. For example, the oil majors still have a delicate balancing act to perform if they are to transition to integrated energy companies, without weakening the prospects for their core fossil fuel assets. With oil at US$76 per barrel and clearly headed higher, they certainly won’t want to do that.
Mining companies too face challenges in ESG terms. While they can lay claim to providing the metals that will help drive the transition to green energy – from copper and battery metals, to the platinum, group metals used in catalytic converters – mining remains a messy and sometimes hazardous business.
However, when it comes to investing for income, owning shares that generate dividends makes a good deal of sense in an environment where the economy is growing and corporate profits are rising. UK equity income funds additionally have the great advantages of diversification and the potential to omit companies with temporarily or permanently compromised dividend strategies.
With companies expected to yield around 3.7% this year, investors might expect to see straightforward UK equity income funds achieving yields of between 4% and 5%, though this cannot be guaranteed. Yields may be higher than this from funds that also invest a proportion of their assets in high yield corporate bonds or use financial derivatives to boost their income streams. Investors should be aware, however, that higher incomes derived using either of these two strategies generally limit the ability of funds to also generate long term capital growth and/or a rising income over time.
The Franklin UK Equity Income Fund features on Fidelity’s Select 50 list of favourite funds. It benefits from being run by an experienced four-strong management team based in Leeds led by the income investing veteran Colin Morton. Among the Fund’s 47 current investments are large holdings in AstraZeneca, Unilever, Royal Dutch Shell and Rio Tinto. The Fund pays a quarterly dividend and currently yields 3.6% based on payments over the past 12 months8.
Investors in the Select 50 UK growth funds Majedie UK Equity (Shell, NatWest Group) and Liontrust UK Growth (BP, Shell) will also have found plenty to be positive about in last week’s slew of results.
1 FTSE Russell, 30.06.21
2 Morningstar, 10.07.21
3 Barclays, 28.07.21
4 LloydsBanking Group, 29.07.21, and NatWest Group, 30.07.21
5 Rio Tinto, 28.07.21
6,7 Royal Dutch Shell, 29.07.21 and 07.07.21
8 Franklin Templeton, 30.06.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. The Franklin UK Equity Income Fund, Artemis UK Select Fund and Liontrust UK Growth Fund invest in a relatively small number of companies so may carry more risk than funds that are more diversified. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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