Interactive Investor

Dividend warning issued

26th November 2015 12:01

Lee Wild from interactive investor

If the economy stutters in 2016, dividends are at risk more than ever. Dividend cover - the number of times a company can pay its dividend out of after-tax profit - has continued to fall over the past six months and is, warns Panmure Gordon's chief economist Simon French, "unsustainable and poses substantial investment risk to the unwary investor".

Companies had already borrowed heavily - up to £130 billion between 2011 and 2013 - to bankroll dividend growth, and have since slashed spending to make up for a shortfall in earnings. And over the past four years, forward dividends per share have risen 6% despite a 32% slump in forward earnings per share (EPS).

At 1.67 times, dividend cover is at a 20-year low, and at a time when the market has cut EPS forecasts for UK companies by 15% - it's just 3% in the US and Germany.

"This further reduces the resilience of planned pay-outs against an unexpected decline in global macro conditions," says French. "Equity selection joins market timing as the key factors in generating alpha [market outperformance] in today’s UK equity market."

It's why French and the Panmure team have screened for stock-specific resilience using an approach that has returned 6.7% since their last selections were last published; that's 15.5% more than buying the market.

Resilient or vulnerable?

Now, the broker takes a fresh look at the constituents and names its "resilient" portfolio of stocks to grow and protect their dividend. It also scans for those companies that are "vulnerable" to any deterioration in earnings.

There are some standout sectors here. Dividend cover at Telecoms, Healthcare, Industrials, Consumer Goods, Oil & Gas and Basic Materials are all at 20-year lows.

Consumer Services is the only sector with cover in excess of its lower quartile, and only the Industrials, Technology and Consumer Services sectors have cover in excess of two times.

Interestingly, the Telecoms sector has insufficient forecast EPS in 2016 to meet planned dividend payments.

Panmure remains "overweight" UK equities, given the loose monetary policy across the globe and rock-bottom commodity prices which underpin economic growth. And the dividend yield among domestic shares is an attractive 3.5%.

But some payout plans have "overstretched their earnings generation capability," warns French. "These are set to retrench in the coming months".

Here's Panmure's take on which UK dividends are safe, and which are at risk of a cut:

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.