UK dividends are back, baby

It’s been a tough few years for UK dividend investors. The onset of the pandemic in 2020 scared the life out of UK plc enough to make most firms slam the divi doors shut. 

Some, like the nation’s banks, didn’t get a choice.

But, two years on, those hinges are swinging open according to the latest Dividend Monitor report from investment admin firm Link.

The overriding message seems to be that dividends are now firmly back on the table but the overall recovery won’t be equal. The war in Ukraine, the tail end of the special dividend flurry and firms continuing to assess the Covid wreckage all point to a very different picture than the one that has lifted a lot of dividends up to now.

So, what’s the state of play now and what should dividend-hungry investors expect next? 

Here are three themes to keep an eye on.

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1. Oil now, miners next?

BP managed to rack up its best quarter for earnings in over a decade this week and profits at Shell nearly tripled as oil and gas prices surge around the world.

Reduced supply, as a result of global tensions around the war in Ukraine, boosted bottom lines. So it’s maybe no surprise to see the oil sector play a leading role in the UK’s ability to pay out £14.2bn in dividends in the first quarter of 2022. 

Oil companies raised payouts by 29% (£505m) according to Link, with the firm expecting the sector to shell out more than £9.5bn this year. That’s quite a bump from the £7.3bn it paid out between Q3 2020 and Q2 2021.

So, oil has led the way so far but it’s mining that’s the sector to watch next, says Link.

With inflation running high, investors have flocked to raw materials and precious metals in search of a hedge against price rises across the economy. And on the ground, sanctions on commodity-heavy Russia and sluggish supply chains still grappling with Covid have boosted prices in the sector.

That reduced supply and bolstered cash piles could mean the next wave of dividend recovery comes from the players forced to trim the fat over lockdown and emerge as lean, mean mining machines.

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2. Special dividends & buybacks: so hot right now

Every sector saw dividends rise in the first quarter, once you strip out exchange-rate impacts and the effect of companies like BHP leaving the London Stock Exchange for Aussie shores.

But away from hikes to regular dividends there’s been a rush to return cash to shareholders through buybacks and special dividends.

Special dividends are always nice to see land in your account but, to a certain extent they obscure the bigger picture. 

Investors can’t plan for them and, while they normally come as a result of a one-off windfall for the firm (Tesco selling its Asian businesses, for example) it’s been a sense of relief that has prompted so many over the past year. And we can see that in the numbers.

Special dividends hit £934m in Q1, a big dip from the £6.2bn paid in Q1 2021 when many firms released cash after shutting up shop early on.

So, we should expect to see a few more as firms finally find their feet after Covid. As a result, income investors will have to swap overall dividend consistency for businesses returning confidence and shedding cash in the short term. Not a bad trade-off given what they’ve had to deal with over the past few years.

Again though, this won’t be a one-size-fits-all situation. Insurers, miners and banks might be able to flash the cash a bit more, and even retail has flexed the special dividend muscles with B&M and Next paying special dividends in Q1. 

But travel and leisure firms aren’t there yet. Package holiday operators like On The Beach and the bulk of the airlines still have their work cut out and now have the headache of lofty oil prices to contend with.

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3. Dividends could hit £92bn in 2022 but watch out for cost pressures

Link expects dividends to hit £92.2bn in 2022. That’s a 0.8% fall year-on-year and largely reflects the reduction in one-off special dividends, as well as miner BHP’s departure from London.

But markets rarely only have one thing to worry about and, as Covid fears hopefully fade into the background, inflation is very much centre stage.

If companies find they can’t pass price rises onto consumers and have to accept squeezed margins, we should get ready for that to hit earnings and, by extension, dividends.

While there may be some juicy yields on offer, remember to make sure those earnings are strong and consistent enough to keep the dividends flowing.

In short, a company’s ability to pay a dividend matters more than the dividend itself.

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Tips to test a dividend 

Start by looking past the top line figure, to the dividend cover.

Is the firm actually going to be able to pay you that figure, and stay in business, or are you being hypnotised by the big percentage when the rest of the business is suffering?

And income payments might resume but if the share price stumbles across the bottom of the page it's not going to make your portfolio any happier.

Looking at the levels of cash on the balance sheet can help sort the dividend leaders from the basket cases too.

Quite often the top dividend stocks of the moment stop being so good after that.

For a temperature check of what’s on offer, here are some of the highest dividend yields on the UK market right now. Remember though, don’t get doe-eyed by these numbers, dig into whether they’re likely to stick around or not.

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Past performance is not a reliable indicator of future returns. The value of your investments, and any income you receive from them, can go down as well as up and you may get back less than you invest.

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Source: dividenddata, 4 May 2022.

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*Indicates the company has made a dividend cut to the most recent dividend or has stated that the next dividend will be cut. This may indicate that future dividends and yield will be lower. Source: dividenddata, 4 May 2022.

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