Swings and roundabouts: Income investors should prepare for a dividend hangover

 
Justin Cooper
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While investors enjoyed the party last year, they should expect to feel some of the after-effects in 2018 (Source: Getty)

Investors had a spring in their step as we entered 2018.

A record high for the stock market was matched by record dividends paid by the UK’s listed companies – a staggering £94bn, up 10.5 per cent on 2016.

The UK’s largest companies are mostly multinationals that saw revenues boosted by a resurgent global economy.

The mining sector is the most dramatic case in point. Commodity prices have rebounded from multi-year lows in 2015, as demand for metals and minerals has recovered. That, combined with the fruits of restructuring, has boosted profits for mining companies and allowed them to restore dividends that had been cancelled or cut to the bone.

Their return to form accounted for a little under half the £8.3bn annual increase in UK payouts last year.

Dollar dominates

Exchange rates are a major factor, and the weakness in sterling boosted dollar-denominated payouts.

Two fifths of UK dividends are declared in dollars. In fact, the three largest payers – Shell, HSBC, and BP – all declare in dollars, and they alone account for 27 per cent of all dividends.

In 2017, the pound was weaker against its peers than in 2016. That meant the value of payouts was boosted by £2.1bn, as these payments were translated at more favourable exchange rates.

The specials

Special dividends were also a major feature, and 2017 was the second consecutive year in which they were unusually high.

One-off specials totalled £6.7bn, with almost half of this due to the National Grid’s payout from the proceeds of its UK gas distribution disposal. In June last year, National Grid returned £3.2bn to shareholders through a special dividend – therefore boosting the UK’s headline growth rate.

Read more: Shareholders in National Grid approve chief executive pay

But for the year ahead, we expect special dividends to drop, to bring them more in line with their historical average.

Meanwhile, exchange rate gains are also set to reverse given the rise of the pound against the dollar.

In fact, for every cent that sterling climbs against the US currency, £300m is wiped off the annual total of dividends in sterling terms.

If the pound averages $1.35 (the exchange rate at the start of the year), investors will see losses of £1.7bn in 2018. While sterling dropped again over recent weeks, it strengthened drastically against the dollar at the start of the year.

The party is over

We are fundamentally optimistic about dividend growth from UK plc in 2018, as rising profitability supports company cash flows.

In fact, we expect dividend growth of close to five per cent for the full year on a constant-currency basis.

However, once we factor in the exchange rate, and the likely lower level of special dividends, headline growth will be much slower.

In our recent Dividend Monitor report, we forecast headline growth of 1.6 per cent to a total £95.9bn. If the pound sustains its current exchange rate for the whole year, that growth may be wiped out altogether.

Despite what some may think about share price valuations, investors should not be concerned about their income. Over the long term, we expect dividend growth to continue as exchange rates tend to even out.

While investors enjoyed the party last year, they should expect to feel some of the after-effects in 2018.

That doesn’t mean dividends are fundamentally in danger. Growth will continue this year, even if it is at a slower rate.

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