Used as measure of showing how sustainable a companies dividends are, data from the The Share Centre’s Profit Watch UK report and the Capita Asset Services UK Dividend Monitor, shows UK dividend cover fell for the second consecutive year, dropping from 0.97x to 0.80x.
Dividend cover is the ratio produced by dividing profit after tax by the dividends paid out to shareholders. A higher ratio suggests dividends are more sustainable and affordable for companies.
However, when dividends exceed profits, the ratio falls below 1, which highlights the unsustainability of dividend payouts. According to The Share Centre, profits made by companies listed in the FTSE 350 in the year to the end of December 2016 and reported by the end of March 2017, fell 7.6% to £67.3bn.
In contrast, over the same period, dividends for the same companies have increased 7.1% to £81.1bn. As result, dividends have exceeded profits for five consecutive quarters, the longest such run since at least 2008. Cover is also less than half the level seen just two years ago.
“Dividend cover is still weakening, and this will ring alarm bells for income investors, especially as the outlook for the UK economy is moderating,” says Helal Miah, research investment analyst from The Share Centre.
“Consumer spending is down, manufacturing growth is slowing, and the housing market is slowing. For domestically orientated companies, especially those in the 250, this will impact sales and profits, and is likely to weigh on dividends.”
Indeed, according to the research, dividend cover weakened more severely in the mid-cap 250 than among the top 100 UK companies. In the 250, dividend payouts increased by 3%, in spite of a 16% fall in net profits. This drove dividend cover down to 1.2x, its lowest level since the recession.
However even at this low level, 250 firms still have stronger dividend cover than in the 100. This is because while large cap profits only fell 11%, dividends increased quickly at 8%. Therefore, their cover also fell to 0.7x, as payouts exceeded net profits for the second year in a row.