Flat markets conceal some large variations between sectors

by Robert Davies, Fund Manager

Last summer UK investors were nervous about the outcome of a Scottish Referendum and the General Election but were enjoying the benefits flowing from oil and iron ore both trading at over $100 a barrel and a tonne respectively. One year on political uncertainty has been eliminated but both those commodities are trading at half the levels they were and yet the stock market is little changed, down just 2% over the year.  

And it is not just commodities that have been repriced. Sterling is now trading at 1.56 to the dollar whereas a year ago it was worth 10 cents less. That 6% appreciation has a major impact on UK businesses that have a sterling cost base yet a revenue stream largely denominated in dollars. This has hurt revenues and margins for many mid-sized British businesses as evidenced by some interim trading updates released over the summer. 

These changes might be expected to have a significant impact yet, rather oddly, the shape of the UK stock market has not changed dramatically.  HSBC is still the largest company by market capitalisation and also by its share of forecast dividend payments, despite the gyrations of the Chinese stock market. It is followed by the combination of Shell A & B shares and then BP.  This is even after the 26% fall in the Oil & Gas Producers sector in the last twelve months. 

More change has occurred lower down the list where, for example, Lloyds Banking Group has moved up from the 13th to 7th largest dividend payer as it has returned to making distributions. Interestingly, the opprobrium that still taints bank shares means that its popularity, as measured by market capitalisation, means it still ranks below its importance as a dividend payer.  Measured by price it accounts for 2.25% of the index even after its 13% rise over the year, while measured by dividends it is 3.22%.  That difference of almost one percentage point is more significant than it might seem as there are only 24 companies that have a total weight of more than 1% when measured by price and 23 when measured by dividends. 

Perhaps more surprising is that the expectations of future dividends have actually increased over the twelve month period despite the adverse effects of lower commodity prices and unfavourable exchange rates.  In the middle of 2014 analysts collectively expected companies listed on the UK stock market to pay out £84.9 billion in dividends in 2015. One year on that forecast (now of course for 2016) has increased nearly 6% to £89.2 billion.   Some of that increase is, bizarrely, coming from the Mining Sector which has actually been the worst performer, with a 39% price drop, over the past year.

It can be argued that simply means that some companies have yet to advise the analysts that dividend cuts are on the cards.   The trouble is that companies rarely flag that in advance. Last year Tesco was still predicted to pay out over £1.1b in dividends and it was the 26th most valuable company in the UK.  Now it is the 29th by price and 39th by dividends and will only pay out £310m.   

Centrica was another company that had to cut its dividend so it share of the dividend pie has fallen from 1.09% to 0.69% and has moved down the price rankings from 31 to 35 with its 14% decline.  

In contrast to the reluctance of commodity producers to cut dividends in the face of lower prices two beneficiaries of that change have already flagged their intention to increase distributions. EasyJet and Carnival Cruise Lines are both big consumers of oil based fuels and their shares of the dividend pie have increased from 0.21% to 0.26% and 0.59% to 0.65% respectively. It is therefore not surprising that the Travel & Leisure Sector has gained 22% over the past year.  

House Builders is another sector that sees better times ahead. Taylor Wimpey is now expected to account for 0.39% of UK dividends, up from 0.27% while Barratt Developments has gone up from 0.16% to 0.31%.  However, it is one of the smaller builders, Redrow that has performed best with a gain of 85%.   

These changes have been reflected to varying degrees in the respective share prices but, in the overall scheme of things, it is clear that while there have been minor changes in the shape of the pie it has not changed substantially over the course of a year that has seen major changes in the economic landscape.   Even though the euro crisis rumbles on, and the threat of Britain leaving the EU is starting to replace the Scottish issue as a focus for concern, political worries have largely faded away to be replaced by economic ones.

These will bring other issues for investors to fret over and, in the short term, will create winners as well as losers.  What is certainly clear is that the past year has seen better returns from smaller stocks, perhaps enhanced by liquidity squeezes, than the larger companies in part because they have experienced bigger changes to their business environments.  But, at some point, those liquidity issues could turn into negative factors and prices might move more sharply than the fundamental factors would imply.