The Covid crisis prompted many businesses to cut or cancel their dividends in 2020. Although uncertainty remains, this year’s economic recovery means we are now starting to see those dividends return. In this article, Nick Purves examines the outlook for UK dividends and the implications for Temple Bar investors.
A change is gonna come
It is sometimes said that ‘It’s an ill wind that blows no good’, and in one respect this has proven to be the case with companies that were already having to adapt to secular change in their industries. As a result of the short-term strains that resulted from Covid, companies were forced to accelerate change that was already necessary but would have taken some time to bring about. Several companies that we regularly talk to have said that a change that might previously have taken three-to-five years to bring about is now happening much more rapidly. Companies often surprise in their ability to adapt to a new operating environment – that seems to have been the case here, with many using the crisis to significantly re-engineer their business models. This provides comfort that they may be able to regain prior levels of profitability and grow their profits over the long term.
Back to black
Although we couldn’t know it a year ago, the success of the vaccines has enabled economies to open up more quickly than we would have dared to imagine. Whilst there continues to be a high level of uncertainty, the recovery of the last nine months has certainly been vigorous. The sharp slowdown that we saw in 2020, makes year-on-year comparisons largely meaningless and it is therefore more instructive to compare today’s activity levels with those of two years ago. Some sectors of the economy continue to operate much below 2019 levels (travel and leisure, for example), but many have now largely recovered (such as industrial goods, advertising, retail and housebuilding). The very significant rally in commodity prices (often to levels much higher than they were in 2019) also suggests that economic activity has largely normalised, at least for the time being.
At the company level, the combination of economic recovery and reduced costs has led to a sharp rebound in profits for many businesses and, although the stock market has responded to factor in the improved backdrop, in many cases, share prices have failed to keep pace with the profit recovery. The result has been a de-rating of the Temple Bar portfolio to an aggregate price earnings ratio of just 10-11x earnings for 2021. This corresponds to an earnings yield of 9-10%.
How soon is now?
This relatively sudden improvement in fortunes has created a dilemma for company managements as to how quickly and at what level dividends should be reinstated. There is a strong argument to suggest that company boards will be cautious when setting pay-outs as once a board has taken the painful decision to cut a dividend, the last thing that they want is to cut again. We think it is likely therefore that dividend pay-outs are reintroduced relatively slowly, and that dividend cover is progressively run down over time.
There is still room for positive dividend surprises, however, and the portfolio has benefited from several recently. Examples here include BP, which announced that it is now targeting dividend growth of 4% per annum from a starting dividend yield of more than 5%. Meanwhile, Royal Dutch Shell also increased its dividend by 38% in the second quarter and now also targets 4% per annum dividend growth.
The banks were prevented from making dividend payments in 2020 by the regulator. These restrictions have now been lifted allowing the companies to make generous pay-outs once again. Likewise, several retailers and media companies are expected to see increased dividend payments in 2021.
Run for cover
In the medium to long term, and as normality returns, it is not unreasonable to expect that dividend cover might return to historical levels of around two times. With dividend cover today being closer to three times, this suggests that we should be set for a period of strong dividend growth in the years ahead.
Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. The information shown above is for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.
This article has been prepared by Temple Bar Investment Trust PLC (the “Company”) for its shareholders (and is not addressed to or otherwise being sent by the Company to any other parties) and as such is not (by virtue of Article 43 of the Financial Services and Markets Act 2000 (Financial Promotions) Order 2005) a financial promotion for the purposes of the Financial Services and Markets Act 2000.
References herein to RWC Asset Management LLP or “RWC” are in respect of its capacity as the appointed portfolio manager to the Temple Bar Investment Trust Plc. RWC, is authorised and regulated by the UK Financial Conduct Authority and the US Securities and Exchange Commission. RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document.
This article is not intended to be an offer or solicitation of an offer to buy or sell securities in the Company. Furthermore, it does not constitute investment advice or an investment recommendation. Whilst reasonable care has been taken in the preparation of this letter, no responsibility or liability is accepted (by the Company or RWC) for the accuracy or completeness of the information contained in this article including the opinions expressed by the Company and/or RWC.
No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. Please note that the value of investments and the income derived from them may fall and you may get back less than you originally invested. Past performance is not necessarily a guide to future performance and information contained in this document should not be viewed as indicative of future results. Before making any investment decision you are strongly advised to consult your own professional investment or other adviser.