Although the outlook for FTSE 100 dividends paid out in aggregate to investors should see growth both this year and next, the fact that these dividends are coming from a small core of companies is of concern, says AJ Bell analyst Russ Mould.
His comments come as the online investment platform published its quarterly market overview, ‘Dividend Dashboard’.
Says Mould, pictured left, “The good news is that analysts are still increasing their aggregate dividend forecasts for the FTSE 100 for both this year and next. Consensus is now looking for a 16% increase in 2017 and an 8% increase in 2018, to £85.3bn and £91.6bn respectively.”
The bad news, however, Mould notes, is that analysts have started to cut rather
than increase their aggregate profit forecasts for the FTSE 100, trimming 3% off their forecast for 2017 to £191bn and leaving 2018 forecasts unchanged at £213bn.
The effect of profit estimates going down and shareholder payout estimates going up is that earnings cover for dividends remains much thinner than ideal at barely 1.7 times for 2017 and 2018, he points out.
‘Margin of safety’
“Earnings cover needs to be around the 2.0 times mark to offer a margin of safety to dividend payments, should there be a sudden and unexpected downturn in trading at a specific company, or indeed the UK and global economies as a whole,” says Mould.
“Even though Provident Financial (since deleted from the index) and Pearson
let the side down with dividend cuts,” he adds, “the 50-plus FTSE 100 members to report earnings forecasts over the summer increased their dividend payments by 15% between them,” making up the shortfall created by these two companies, and also that of Sky passing its full-year payment as it prepared to be taken over by Fox.
‘Juicy yields but skinny earnings cover’
Pearson and Provident Financial, Mould says, are both examples of what can happen in the event of a profits stumble under such circumstances, as both had been offering apparently “juicy yields but with skinny earnings cover”.
Any dividends cover of less than 1.0 should “ring alarm bells” for investors as it means that the company is paying out more to its shareholders than it has earned in that year, obliging it to dip into cash reserves or to sell assets to maintain the payment, something that is “unlikely to be sustainable in the long term”, Mould points out.
Even a dividend cover of 1.5 is, he says, risky as it can leave the company vulnerable if profits fall in any given year, leaving it in a position where it will need to decide whether to reduce its dividend, stop reinvesting in the business or take on more debt.
Dividend cover of 2.0 or more ‘ideal’
“Dividend cover of 2.0 or above is ideal because it means profit is double the amount the company is paying out to shareholders,” Mould concludes, saying “this means it can continue to invest in the business and has scope to maintain its dividend payment in a bad year.”