Don’t despair on dividends – these companies could be set to bring them back

The value of dividends paid out by UK stocks has plummeted this year as companies “rebase” their payment policies. But things could soon start to look up. John Stepek explains why, and where to look for income.

In the wake of oil giant BP’s dividend cut this week, we’ve been talking a lot about the pain that income investors have endured. And this morning, commodities group Glencore has scrapped its payout.

And yet, it’s easy to lose sight of the fact that it’s not all bad news.

In the early days of the crisis, several companies postponed or cancelled dividends, purely as a precaution. Now that the lie of the land is somewhat clearer, we’ve seen quite a few of them reinstate their payouts.

And there’s probably more to come. So who might be next to spring a pleasant surprise on dividend investors?

The silver lining on the dividend cloud

It’s been a terrible year for dividend-focused investors. The total value of dividends paid out by UK stocks in the second quarter of 2020 fell by more than 50% year on year. To be clear, that’s much, much worse than the drop seen during the financial crisis. It really is unprecedented (there’s that word again).

On the one hand, you can point out that this has been on the cards for a while. Dividend cover (a measure of whether companies are actually making enough money to pay their dividends or not) in the UK market has been grinding relentlessly lower, meaning that companies were on borrowed time anyway.

Covid-19 gave them the excuse they needed to cut dividends back to a more manageable level. This is known as “rebasing”. What it really means is “we know we’ve been paying out too much but we were scared to cut because shareholders wouldn’t have liked it.” This is what’s happened with the likes of the oil majors, for example.

But, on the upside, that makes future dividend payouts more sustainable. Again, the oil majors are a case in point. The crashing price is forcing them to be more disciplined with their spending, and now they don’t have to break their backs to meet an unaffordable annual dividend payout. Arguably that puts them in better shape than they’ve been in for a while.

On the other hand, all of this lovely hindsight doesn’t help you much if you’re looking at a demolished income portfolio. So where’s the silver lining to this cloud?

Well, not everyone slashed their dividends because they were fundamentally unpayable. Some companies have cut them because they were forced to (banks plus some insurers). It’s worth keeping an eye on that lot, and the banks in particular, because if things don’t end up being as bad as expected, there might be a lot of recovery potential there.

Still others – and these are the ones we’re more interested in today – only cut or paused their dividends on a precautionary basis. This makes sense. If a global pandemic of unknown proportions descends on the economy, accompanied by a worldwide shutdown, there are very few companies for whom preserving cash wouldn’t be a priority.

But we’re getting a better idea of the damage done now. We’re nowhere near out of the woods, but there’s enough visibility that the companies that were being careful can now tentatively start to unfreeze their payouts.

And that’s something we’ve already seen starting.

The companies who might bring back their dividends

UK-listed companies that have reinstated their dividends in recent days include defence giant BAE Systems, insurer Direct Line, packaging firm Smurfit Kappa, property group Land Securities, and industrial firms Rotork and Spectris.

In most cases, reinstatement has been a double boost: not only do shareholders get their payouts back, but the prices have typically jumped. Direct Line, for example, gained 8% on the day earlier this week and Rotork enjoyed a similar gain.

Analysts at Peel Hunt reckon that nearly 30 companies who scrapped their dividends during the first half are likely to bring them back later this year.

Meanwhile, wealth manager Canaccord Genuity recently put together a list of 13 stocks that it reckons will reinstate their dividends before the end of the year. Of those, Rotork and Spectris have already done so.

Who are the other 11? There are four housing market plays: property portal Rightmove, Howdens (kitchens) and Dunelm (furnishings), and builder Persimmon. There’s popular Aim-listed video gaming industry play Keywords Studios. The other names include Oxford Instruments, 4imprint, Learning Technologies, QinetiQ, Softcat and Diploma.

Do I think that any of these are worth buying? At first glance, none of these companies looks particularly cheap right now (with the possible exception of QinetiQ) but you’d have to do your own research on that.

And while these stocks could get a boost from yield-starved institutional investors who are desperately trying to find dividend-paying companies for their income funds, that alone is not a reason to buy.

However, if you are a stock picker and any of these have already made your watchlist, this is another factor to throw into your rationale for investing.

You can read more about why dividends still matter in the next issue of MoneyWeek magazine (subscribe here to get your first six issues free). And if you missed Merryn’s chat with Janus Henderson’s Laura Foll, much of which was about dividend strife and the hunt for income, check it out here.

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