Inflation-busting dividend increases send shares higher

It's tough for consumers right now, with inflation on the rise but wage growth stuttering. Annual inflation in the UK rose last month to a near four-year high of 2.7%, but stats show wages excluding bonuses rose just 2.1%.

When adjusted for inflation, growth in salaries fell 0.2%, the first decline in two-and-a-half years. If investors are to preserve capital, returns must exceed the rise in costs, which means dividend growth must beat the rate of inflation.

So it was no surprise that income-seekers were out in force Tuesday as a number of companies announced big increasesin their dividends, powering their share prices higher. Amongst the main players were utility Severn Trent, which grew its divi this year and raised its growth policy for future years.

Meanwhile, electronics distributor Electrocomponents grew its payout for the first time in five years, by 4.7% as it reported impressive full-year results to 31 March 2017. That sent shares up to record high levels, while Severn Trent wasn't far off that.

Others to register double-digit dividend growth year-on-year included 3%-plus yielders Topps Tiles and Big Yellow, while even the likes of Scapa and Cranswick upped their rather more modest payouts significantly.

After reporting underlying profit before tax of £525 million, up 4.3% year-on-year and 2% above consensus expectations, Severn Trent chief Liz Garfield hailed her company's "strong customer-focused and financial outperformance".

"We feel it is now appropriate to share this with our investors," she added. In order to achieve this, the firm will now aim to grow its ordinary dividend by retail prices inflation (RPI) plus 4%. With RPI in November 2016 standing at 2.2%, this takes the proposed dividend for 2017/18 up to 86.55p per share – a prospective yield of 3.5%.

This sent shares up as much as 2.7% to around the £25 level, just shy of its record of 2,524p set in September 2016. In the interim, the stock had slipped to a low of 2,047p in early December.

Despite the pick up since, broker UBS has kept its 'sell' rating on the company and 12-month price target of £21. Analyst Rui Dias reckons the dividend upgrade was "the highlight of [SVT's] guidance".

Morgan Stanley, meanwhile, said it will be interested in management commentary around how the policy fits in with its credit rating and leverage metrics.

A more positive tone was set by analysts regarding Electrocomponents, but price target upgrades were quickly wiped out as the firm shot up to an all-time high of 562p. Adjusting for currency movements, revenue of £1.5 billion was up 4.8% and pre-tax profit of £128 million was up 36%.

Free cash flow of £118 million was up 88% year-on-year and allowed for a generous 4.7% uplift in the full-year dividend. That was the first time the payout has grown in five years. Boss Lindsley Ruth called it "a major step forward".

"Getting the basics right is now delivering strong top-line growth, stable gross margins, improved efficiency and significant growth in profits and cash flow. With a stronger balance sheet, we are pleased to return to growing our dividend," he added.

Although the yield is a modest 2.2%, dividend cover of 1.7 times is healthy and the board said it "intends to pursue a progressive dividend policy whilst remaining committed to further improving dividend cover over time by driving improved results and stronger cash flow".

In a note to clients, broker HSBC said it was encouraged by Electrocomponents' "common sense makeover" and raised its target price by almost 6% to 550p. At the time of the note, that gave potential upside of over 10%, but a subsequent rally means it looks fully valued on those forecasts. Liberum analyst Rahim Karim's 539p target suggests similar.

However Matthew Lloyd at HSBC points out his target does not make allowances for any future acquisitions as the firm does not tend to be acquisitive, unlike many of its peers. However, he adds, "we believe that acquisitions, if done with sufficient common sense as Bunzl does, can add value and could act as a catalyst for consensus upgrades".

Topps Tiles, the UK's largest tile specialist, has had a rough first half to the year. Its results for the 26 weeks to 1 April 2017 showed year-on-year reductions in both sales and profit. However, it did raise its interim dividend by 10%, to 1.1p. That gives it a forecast yield of around 3.9%.

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.