Investors have been deluged with dividend changes during second quarter earnings season, from BP (BP.) cutting its payout in half to outright cancellations from ITV (ITV) and Glencore (GLEN). Still, it hasn’t been all gloom for income seekers: packaging firm Smurfit Kappa (SKP) is the second FTSE 100 company to reinstate its dividend, while diversified miner Rio (RIO) and silver producer Centamin (CEY) are increasing their payouts, in the latter’s case by a chunky 50%.
GlaxoSmithKline (GSK) tops our monthly list of companies offering decent yields as well as possessing an economic moat, with an expected yield of 4.8%. Just 20 companies make it through our screen, which filters out companies without a narrow or wide economic moat and with a dividend cover of less than 1.25 (which means that payouts are only just covered by annual profits).
Even though Glaxo has benefited from the healthcare and vaccine boom in the Covid-19 crisis – and is one of a handful of notable FTSE 100 companies not to have cut payouts – the shares are still undervalued, according to Morningstar analysts. According to Damien Conover, the fair value for GSK is £18, above the current price of around £15. The stock is just one of seven on our list with a wide economic moat. “GlaxoSmithKline has used its vast resources to create the next generation of healthcare treatments … Patents, economies of scale, consumer brands, and a powerful distribution network support GlaxoSmithKline’s wide moat,” says Conover.
The pharma giant is also the fourth biggest holding in the Morningstar UK Dividend Yield Focus index, with a weighting of nearly 10%. Defence company BAE Systems (BA.), which has an expected yield of 3.6% and takes fourth spot on our list, is also a member of the index, with a weighting of just over 8%.
Dividend Cover Matters
A dividend cover of more than 6 makes Evraz (EVR) the outlier on this list; the next biggest dividend cover ratio comes from life sciences expert Abcam (ABC). Dividend cover matters because it shows how much of a company’s profit is used to pay dividends. A ratio of 1 means all annual earnings are used to pay shareholders, whereas 2 is in normal times considered a comfortable ratio – in effect, a firm can pay dividends twice over from annual profit.
The company with the lowest dividend cover of 1.3 is WPP, meaning it only just makes it through our screen. The advertising and events giant has been hit hard by the dramatic changes to the global economy this year and its shares are down a hefty 43% year to date. Perhaps unsurprisingly then, WPP is the only five-star rated stock on our list; analysts assign its shares a fair value of £13, way above the current price of £6.
London Stock Exchange (LSE) has the lowest expected yield on the list at 0.5% but one of the highest dividend covers, at just over 3. It’s a pattern evident across these 20 companies – the ones with the highest yields tend to have the lowest margin of safety in terms of dividend affordability. In the current economic climate, many companies are understandably choosing to prioritise cash preservation over shareholder payouts.
Disenchanted UK investors can also look further afield for income, to the US for example. Morningstar index strategist Dan Lefkovitz has taken a global approach to search out the companies that are maintaining and even growing their dividends, ruling out those that have cut or cancelled their pay outs. Travel and hotel stocks have been kicked out of Morningstar US indices, for example, in favour of financial and healthcare companies like JPMorgan (JPM) and Visa (V).
He explains why growth is so important: “Dividend growth not only helps investors keep pace with inflation, but it signals strengthening corporate fundamentals. Companies that increase payouts to shareholders also tend to be competitively well-positioned.”