After 12 turbulent months for equity markets, top industry managers believe the worse is now behind them regarding dividend cuts
A year on from the low point in the UK equity market, the outlook is steadily improving for dividends despite the uncertainty over the strength of the economic recovery and the general election outcome.
Although sterling remains low against both the euro and the dollar, the benefit to companies with high overseas earnings is beginning to feed through to the UK equity income funds.
Many managers in the sector believe the worst is over for the dividends.
According to Alex Breese, manager of Neptune UK Special Situations fund and assistant manager on its Quarterly Income fund, 202 companies in the UK cut dividends last year while 179 increased and 60 held them at the same level.
Colin Morton, manager of Rensburg UK Equity Income, says: “I think we have seen the worst of the dividend cuts. As long you will be content with high single-digit dividends of 8% or 9% you are going to be happy.”
Other managers point to the fact although the UK equity market is not as cheap as it was 12 months ago in P/E terms, it still looks reasonable value on an historical basis.
Simon Murphy, manager of Old Mutual Asset Managers’ UK Select Equity fund, says: “We are at about 12x earning now. A normal multiple historically has been 15 or 16x. I could see the multiple going up to 16 over the coming year. You need to have net new money coming into the market for multiple expansion.”
According to an analyst note from Citibank this month, for the first time in two years UK life companies became net buyers in Q3 2009, which is usually seen as a positive indicator.
“Right now, the market does not look ridiculously expensive but it does not look anywhere as cheap as it did 12 months ago. If you use Shiller P/E, the market looks to be in line with long-term average yields,” according to Morton.
Dan Roberts, manager of the £166.7m Gartmore UK Equity Income fund, says: “Throughout this downturn operating margins and returns on equity have been much more resilient than I would have expected them to be, given the severity of the recession.
“We are now looking at profitability levels forecast for next year, which are almost as high as previous peaks in many industries. If you look at the mining or many of the industrial sectors, analysts are forecasting profits next year, which will be as high as they were in 2006/07.
“When you put that together with the valuations some of these companies are trading on, you cannot help but feel the risk/reward is no longer in your favour. This is not the case everywhere in the market and there are sectors we are very keen on. We think pharmaceuticals certainly offer plenty of value, for instance.
“Dividends are being reintroduced in certain sectors, with mining and banks being the obvious ones. It helps the dividend statistics for the market as a whole but they are coming from very low bases in many cases.
“The yield premium of the fund is 25%-30%, so I do not feel the need to scramble around for yield.
“I am finding good value alongside good income and have a good range of sectors in the portfolio. I do not have to rush to the big oil companies or telecoms; I am able to find yields from financials, utilities, consumer stocks etc.”
The company reporting period is well under way and Thursday last week was a good indicator of the mixed results coming from UK-listed businesses, with the likes of Aviva announcing a dividend cut, while companies such as Cobham increasing a 25% increase in payout.
Cobham increased its final dividend by 10% to 3.97p per share and its full-year dividend also rose 10%, while Kazakhmys has reinstated its dividend, bringing its full-year dividend to 9 cents per share.
But Trinity Mirror declared no dividend, after paying nothing in 2009, compared to 3.2p for 2008. Aviva’s final dividend will be 15p, a reduction of 25% on the 2008 final dividend.
Morton says: ‘We have had a very good reporting season so far. The feature has not been about top-line growth, but companies have made big cost savings and shown a strong ability to reduce debt. Figures released last week show capital expenditure at the end of last year was down 25% on the end of last year.
“There are signs again the housing market is starting to come up, but 2010 looks like it is going to be pretty tough for the consumer.”
Simon Gergel, Allianz RCM UK Equity Income manager, says while valuations are probably below average, the economic outlook is also below par.
He says there is a very wide variation in valuations. “A lot of high-growth companies are cheap at the moment because they have been neglected by the market in favour of cyclicals.”
As an example he cites companies like Reckitt Benckiser, which he believes has a decent yield and good longer-term prospects.
Gergel adds: “I think the reason people are ignoring these companies is because, in a recovery people chase performance rather than looking for security.
“But as an income manager it gives me an opportunity to buy companies that are usually out of my range because of the yield.”
