Thank Brexit for your income!

When I blogged on this topic in February last year, I sounded a note of caution that 2016 was unlikely to be plain sailing for income investors. In the event, despite an uncertain start, income-seeking investors experienced another good year. Companies paid out £84.8 billion in ordinary dividends, with an additional £8.5 billion through specials. The outlook for 2017 is more optimistic, owing to the tailwind from sterling’s devaluation, improving commodity prices and conditions for HSBC, as well as reasonable underlying dividend growth.

Dividend growth in the UK market came through at 4.2% in 2016, above CPI inflation of 1.6% in December. This was well below the 8% achieved by the market in 2015, but, to put last year in an historical context, since 1960, real dividends have grown at around 2% per annum.

However, without the boost to dividends declared in a foreign currency from the Brexit-inspired 15% sterling devaluation last year, total dividend payments would have shrunk by around 1%.

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Although there were a relatively large number of dividend cuts in 2016, including some of the UK’s biggest companies, such as Glencore, BHP Billiton, Rio Tinto, Barclays, Standard Chartered, Centrica and Rolls Royce, 90% of the FTSE All-Share’s 640 constituent companies paid some sort of dividend, reaffirming the strong dividend-paying culture in the UK.

A quarter of the companies by value in the index declared non-sterling dividends, which accounted for 45% of the total dividends declared, split 39% in US dollars and 6% in euro. Interestingly, total US dollar dividends actually fell by 11% in local terms, largely reflecting cuts by the miners.

Emphasising how important currency movements were to overall dividend growth in 2016, virtually all the FTSE All-Share’s top 20 dividend growers either declared in a foreign currency or had substantial overseas earnings. Exceptionally, Aberdeen Asset Management benefited from the inclusion of a third dividend in the year. Miners were the main casualties in last year’s top dividend growers as their absence from the following table shows.

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One unfortunate consequence of the currency moves, though, has been to increase the concentration of the UK market from an income perspective. The following table shows that the top-five stocks account for 37% of all market income, up from 32% in 2015, while the top 10 account for 51% and the top 20 for nearly two thirds – a somewhat unsatisfactory trend from the point of view of portfolio diversification and the risk from another Macondo-type incident. Driving the increased concentration was the Royal Dutch Shell/BG merger, which led to more dollar-paying Shell shares being issued as part of the deal and the disappearance of low-yielding BG shares. Furthermore, combined with the increase in the sterling value of its dollar dividend, Shell’s share issuance accounted for a substantial proportion of the market’s dividend growth.

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2016 was another bumper year for special dividends and represented a marked increase on 2015. The payouts were derived from a number of sources, including capital returns after disposals (e.g., Melrose Industries, Intercontinental Hotels and GlaxoSmithKline), re-gearing of balance sheets after several years of cash accumulation (e.g., ITV and Johnson Matthey), special payments in lieu of ordinary dividends (e.g., Barratt Developments, Taylor Wimpey and Persimmon), or genuine special dividends (e.g., Next, Admiral, Direct Line and Lloyds Banking Group).

Looking ahead, the market’s income generation prospects have improved significantly from 12 months ago. With sterling likely to remain weak, the currency effect will continue to provide a considerable boost to dividend growth in 2017. In addition, the impact of any further cuts should be much reduced as the main suspects have already acted, and there has been a pick-up in the key commodity and bank sectors. The oil price appears to have stabilised around US$50 per barrel, which means that Shell and BP should be able to maintain their dividend payouts, although neither company is cash positive at this level. Also, the recovery in metals prices holds out the prospect that some of the bigger miners could return to increasing dividends this year. Similarly, rising US interest rates will benefit trading conditions for HSBC, improving the sustainability of its dividend. On the other hand, doubts still hang over the dividend outlook in the pharmaceuticals and telecoms sectors – a reflection of weakening balance sheets and a lack of dividend cover. However, any negative impact from these should be overwhelmed by the currency tailwind and reasonable underlying growth elsewhere.