Blackfriar: Now the shareholders mustn’t get greedy for dividends

Following the Shareholder Spring, when investors refused to back company boards’ extravagant ‘fat cat’ pay-outs to directors, shareholders have become far more powerful.

While this has to be a good thing – PLC’s must always act in the best interests of shareholders – a worrying trend has emerged over the past few years.

Dividend cover has dropped to its lowest level in three years as firms give in to investor demands for more income.

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Yet just as fat cat greed should not be tolerated, this hunger for dividend payments when companies are struggling is not healthy for UK PLC.

According to research by The Share Centre, which buys and sells shares for private investors, dividend cover sank to a three-year low of 1.4 times, down from 2.3 times in 2011. Dividend cover is worked out by dividing post-tax profits by the dividends paid out.

The higher the ratio, the more profits are available to pay out to shareholders in dividends. A higher level also makes it less likely that a downturn in profits will necessitate a cut in the dividend.

The research showed weak company profitability is to blame as dividends have raced ahead.

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Helal Miah, research investment analyst at The Share Centre, said: “Companies are under constant pressure from shareholders to sustain dividend flows, even under difficult economic conditions.

“With fixed income investments yielding such paltry returns, equity investors have clamoured even louder for dividends. Company boards have acquiesced, allowing payouts to rise faster than profits over the last three years, leading to a sharp fall in dividend cover.”

Blue chip FTSE 100 companies have shown greater resistance to shareholder pressure with greater stability in dividend cover than the FTSE 250, which paid out dividends even while it made collective losses in the recession of 2009.

This is a worrying trend.

Collectively, the FTSE 250 made losses in 2009, but these firms sustained a large portion of their dividend payments.

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This meant that dividend cover ratio for the index was actually negative for a time in 2009 as in total, companies paid out money they were not banking as profits.

In 2010, a sharp rebound in profits with a much more modest recovery in dividend payments meant a peak dividend cover of 2.5 times for mid-cap firms, but this fell to 1.5 times in the year to the end March 2013 as dividends grew while profits from mid-sized firms have remained lacklustre.

Mr Miah said that profitability is improving this year, so the good news is that dividend cover should begin to turn around.

“There are good signs of economic growth emerging and asset writedowns should feature less in company reports,” he said.

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Richard Hunter, head of equities, at Hargreaves Lansdown said that dividend cover of over two is considered safe, but by the same token, anything under 1.5 could be a warning the company may not be able to maintain the current dividend payments.

So how do Yorkshire’s FTSE 350 companies shape up?

Analysts at Shore Capital have identified Saltaire-based set-top box maker Pace as one of their favourite dividend picks. The company has been undergoing a renaissance under new management and thanks to a sharp jump in trading, dividend cover is 6.56 times, making it look a tasty prospect.

North Yorkshire power station Drax, which is in the process of switching from coal to biomass, is the only other Yorkshire-based company among Shore Capital picks.

With a dividend cover of 2.1 times, it is considered safe under Mr Hunter’s guidelines.

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Bradford-based grocer Morrisons – one of only two Yorkshire companies in the FTSE 100, the other being Snaith-based natural chemicals company Croda – was identified last November by Mr Hunter as being one of the FTSE 100 constituents with the strongest dividend growth over the last four years.

With dividend cover of 2.26 times and hopes riding high on the launch of the firm’s internet offering in January, the stock looks well covered.

Croda, on a dividend cover of 2.02 times, also looks like it could be worth a punt.

Exane BNP Paribas has upgraded its rating for Croda from “neutral” to “outperform” following the stock’s under performance so far this year.

Exane said that Croda’s business remains “rock solid”.

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“Recent weakness appears nothing more than bad weather and unfavourable foreign exchange,” Exane analysts said.

They added that the second half is expected to be the start of a recovery cycle for Croda and the bank estimates a mid-term sales compound annual growth rate of around six per cent in 2013- 2016.

It appears that while some FTSE 350 companies are taking risks, Yorkshire’s elite are staying prudent and should be well able to maintain payments as the economy picks up.

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