During the ultra-low-rate environment that characterised the prior decade, a dearth of credible income options was a primary driver of investor demand for higher-yielding dividend stocks.
However, with rates expected to remain higher for longer, income sources with perceived lower risk – such as credit, government bonds, and even cash – are once again catching the eye of investors.
#According to Computershare’s UK Dividend Monitor for the third quarter of 2023, UK equities are offering a 4% yield over the next 12 months, slightly below the 10-year gilt yield of 4.16% yield. The same report found UK dividends fell 8.3% in the third quarter 2023, owing to steep falls in mining company dividends and lower one-off special payments.
Nevertheless, despite the recent dividend decline and accelerating investor appeal for asset classes beyond equities, we still believe stocks offer the best prospects for stable long-term income and capital growth. As always, sector and stock selection are key, while closely adhering to a tried and tested process.
Focus on stability and sustainability
Assessing a company’s ability to pay dividends is multifaceted. The most common metric is dividend cover – the ratio of a company’s profits divided by the dividend paid to shareholders – which indicates the long-term sustainability of dividends.
A higher ratio enables corporates to maintain consistent dividend payments and use any additional proceeds for business investment, or to boost dividends if investment opportunities are less appealing.
However, this should not be the only metric investors take into consideration. Other aspects such as sustainable earnings, healthy profit margins, low gearing and solid cash generation are vital when assessing a company’s ability to maintain dividend payments through a cycle. These factors are particularly important in uncertain economic environments, such as the one we are encountering today.
In addition, there is a common misconception large-caps outperform small-caps in terms of dividend payouts. This belief stems from the fact small-caps are typically more ambitious by nature, which could result in unpredictable cashflows and hinder the ability to pay dividends.
However, there are opportunities to obtain compelling dividends across the market spectrum, in both established giants and dynamic smaller entities. We have numerous examples of small-cap companies that have demonstrated solid and resilient long-term financial performance.
Withstanding continued consumer crunch
Many such businesses reside in the consumer staples sector. Here, despite the continued cost of living pressures, demand for essential goods – such as food, beverages, and hygiene products – remains steady.
A case in point is Premier Foods, one of the UK’s largest food manufacturers, which has delivered a 20% compound annual increase in its dividend yield from 1p per share in 2021 to 1.44p in 2023.
This has been supported by encouraging ongoing organic revenue growth through new product development, category expansion and market share gains, leveraging strong market position and brands within categories.
Furthermore, maintaining gross margins despite the backdrop of input cost inflation and continuing to drive operational efficiencies has driven strong profit growth and net debt reduction.
The dynamics are different in the consumer discretionary sector, as the increase in the cost of living threatens disposable incomes. However, Ten Entertainment, a UK based operator of 51 bowling and family entertainment centres, saw a rise in its dividend yield from 1.18% in 2022 to 3.68% in 2023.
While Ten Entertainment understandably withheld distributions during the height of the pandemic in 2020 and 2021, it has since delivered a strong rebound. The company emerged from the pandemic to deliver over 50% revenue growth compared to pre-pandemic levels, driven by strong footfall as the value proposition centred around low-ticket experiential leisure resonated with consumers.
Additionally, improved site utilisation contributed to rising profits, resulting in a record profit before-tax margin of almost 25%.
Elsewhere in the consumer space, B&M, a discount retailer within the UK and Europe, is a good example of growth and resilience. Benefiting from remaining open during lockdowns, B&M posted strong profits and growth during Covid, however, has continued to trade well and execute on their core growth strategy.
With a clear focus on earnings before interest, taxation, depreciation and amortisation (EBITDA) and cash flow B&M continues to leverage its consistent low-price offering, supply chain strength and flexibility and data-driven approach to store optimisation.
Consequently, the company delivered greater EBITDA than during its peak trading period in Covid and reported an increase in interim dividend from 5.0p in 2023 to 5.1p in 2024.
B&M opened 13 new UK stores in 2023 and is strategically expanding in this year with 45 planned new store openings and the acquisition of up to 51 ex-Wilko stores. These new investments and a robust store opening programme set the stage for B&M’s future growth in the years ahead.
Brendan Gulston, is co-manager of the WS Gresham House UK Multi Cap Income fund. The views expressed above should not be taken as investment advice.