BP effect masks wider UK dividend growth

U K shareholders’ dividends will fall by 6.5 per cent in 2010 to £54.7bn, mainly as a result of BP’s move to suspend its pay-outs, according to new research. But, looking beyond BP’s difficulties, conditions are improving for income investors as more mid-sized companies are returning cash to
shareholders.

“BP was the largest dividend payer and it is wiping out all the growth in the market,” says Philip Matthew, manager of Jupiter’s Growth & Income fund. “But if you don’t hold BP, you’re fine because most other UK companies have been growing their dividends. The biggest issue for 2011 will be the strength of companies’ earnings.”

Research published this week by Capita Registrars estimates that the cancellation of BP’s 2010 dividend has cost shareholders £5.4bn. Strip this out, however, and the underlying trend for UK dividends is positive.

This year, UK cyclical companies – whose revenues are linked to the economic cycle – have grown their dividends more rapidly than defensive companies, which tend to return cash at a steady pace.

In the first half of this year, 39 more companies – most of which were cyclical – paid a dividend, compared with the same period a year ago. Meanwhile, the number of companies that have increased or reinstated their dividends rose to 189 in the first-half, which was double the number reducing or cancelling their pay-outs.

Mid-sized companies appear to be recovering from the effects of recession more quickly than larger groups. Paul Taylor, head of dividends with Capita Registrars, says: “The FTSE 250 is still paying a third less than in the first half of 2008, but it is growing its dividends quickly.”

In the first half of this year, FTSE 250 companies increased their distributions to shareholders by 24 per cent, compared with the first six months of last year, paying £2.4bn, the research shows. By contrast, FTSE 100 companies, which bore the brunt of the BP effect, slashed their pay-outs by 8.3 per cent, to £25.2bn.

But FTSE 100 stocks still account for the largest pay-outs, which is why analysts still recommend them. Their current “buy” lists include pharmaceutical group AstraZeneca yielding 5 per cent, its rival GlaxoSmithKline on 5.5 per cent, British American Tobacco on 5.1 per cent, Vodafone on 6.7 per cent, and energy company Centrica on 4.4 per cent.

Mick Gilligan, head of research with the advisory firm Killik, thinks equities will continue to offer attractive yields to investors willing to take on more risk. He points out that, even after an adjustment is made for the loss of BP’s pay-out, the prospective yield on UK equities for this year is still 3.6 per cent. This yield beats the return on cash deposits and UK government bonds. It is also higher than the 30-year average for UK dividend pay-outs, which is 3.1 per cent. “Strong corporate balance sheets provide the flexibility to pay progressive dividends to shareholders,” Gilligan concludes.

Fund analysts say that the BP oil spill has showcased the risks of investing too heavily in FTSE 100 income stocks, which produce about 90 per cent of the UK’s dividends. As a result, more investors are moving into global income funds, which invest across Europe, Latin America, Asia and the US. Two income stocks held by Richard Greenwood, manager of Bedlam’s global income fund, which targets a 4.5 per cent pay-out, are the Hong Kong television broadcaster TVB, which yields 5.5 per cent, and Propharma, the Brazilian pharmaceuticals firm, which yields 3 per cent.

But hunting for income stocks further afield is equally challenging. “Certain markets like Singapore and the US are better than others,” Greenwood says.

In the wake of the BP debacle, financial advisers are encouraging investors in UK equity income funds to review their holdings. Principal Investment Management, a UK advisory firm, for example, recently drew up a list and ranked UK equity income funds as either stellar, fair or dreadful. “Cream of the crop” performers included star manager Neil Woodford’s Invesco Perpetual Income fund, which offers a 4.2 per cent net yield, Threadneedle’s UK Equity Income offering 4.9 per cent, Neptune Income offering 4.9 per cent and Artemis Income offering 4.8 per cent.