Interactive Investor

15 stocks at risk of dividend cut

3rd May 2016 17:23

Harriet Mann from interactive investor

FTSE 100 dividends are fast approaching all-time highs compared with their earnings, fuelled by a much-longer-than-expected period of rock-bottom interest rates. With a payout ratio of 70%, London's premier index is paying out £7 of every £10 of profit as dividends, despite many feeling the pinch from falling sales. After screening the market to see which UK stocks are at risk of a dividend cut, Canaccord Genuity thinks 15 are skating on very thin ice.

"The fact that many of these companies are troubled, shows that companies are under pressure to keep dividends up, even when revenues are trailing off," says the broker.

Of course, dividends aren't the only way investors can grow their returns. Instead of signing heavy dividend cheques, companies can reinvest earnings to support long-term growth and their market value. By securing long-term cash flow, dividend payments should look after themselves.

Low interest rates have provided the ultimate environment for yield-hungry investors and the hunt for income has driven equity prices sharply higher. But central banks will inevitably increase rates at some point and, as the demand for stellar pay-out ratios subsides, equity prices could retrace. After all, it was Warren Buffet who said: "Only when the tide goes out do you discover who's been swimming naked".

When companies try to win over the market with dazzling dividend payments, things can go disastrously wrong. Last year saw a number of high-profile dividend cuts, with food retailers Tesco, Sainsbury's and Morrisons, miners Rio Tinto, BHP Billiton, Anglo American and Glencore wielding the knife. Payouts from Barclays, Standard Chartered, Centrica, Rolls-Royce and Amec Foster Wheeler were also cut.

"In Rio Tinto's case this was particularly embarrassing, given that CEO Sam Walsh had been extremely vocal of their ability to pay a progressive dividend throughout the cycle. Such was their apparent confidence that they continued to repurchase their own shares throughout 2015," says Canaccord's senior equity analyst Simon McGarry.

With OPEC's latest figures pointing to near-record output and Brent crude slipping to $45.5 a barrel, a "lower for longer" environment, rather than sustainable recovery, appears most likely. Any near-time bounce in dividends across the energy sector is unlikely.

"As a result of the underlying backdrop, we feel that investors should be more wary than usual of investing in stocks were a dividend cut is likely," warns McGarry. "Going forward, vigilance is the watchword."

Canaccord has drawn up a list of UK stocks most at risk of a dividend cut (see table above). McGarry's six-point criteria includes: a dividend yield of over 3%, covered less than 1.7 times by earnings, falling earnings per share (EPS) in both the current year and last year, net debt higher than cash profit, and negative projected cash flow returns this year.

Those thrown up by Canaccord's machine include industrial maintenance and repair group Brammer, bank note printer De La Rue, utility group Dee Valley and drinks giant Diageo. Electronics distributor Electrocomponents, telecoms colossus Vodafone and satellite firm Inmarsat are also at risk. So are foodie Tate & Lyle, stamp collector Stanley Gibbons and media group ITE.

After recent horrors in the mining sector, it's unsurprising that Rio Tinto and Vedanta make the warning list in addition to oil valves and seals outfit Weir, metals engineer Vesuvius and Fenner, which supplies conveyor belts to mining companies.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.