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Dividends and Marmite

21 October 2016

How sustainable are company dividends in the current environment in the UK, given the prospect of low and diminishing growth?

Dividend yields in the UK will continue to be a key contributor to the average investor’s total return. This is particularly important given the lack of returns available in other asset classes in the current environment.

Around 70% of UK earnings are derived from markets other than the UK. For the large FTSE All-Share stocks in particular, this means there are always areas of growth they can exploit. A weak pound also brings benefits when foreign earnings are translated back into home currency.

It is possible that earnings growth disappoints, as it has done in each of the last three years, and dividend growth turns out lower than is currently assumed. But for the UK market as a whole, there is no sign that the current level of dividend payments is being imperiled. Corporate debt levels remain sensible and interest bills are affordable. Corporate tax rates are low and set to decline a little further. The surplus of earnings relative to current dividend payout ratios is currently at levels whereby a global recession is the only real threat to what is currently paid out to shareholders.

However, at present a number of UK companies face rising costs due to higher wages, currency movements, commodity price changes and pension obligations. This, combined with low growth, may result in specific dividend cuts. As a result, it is important to select the right stock to ensure a reliable dividend income.

What is the outlook for consumers’ wallets following the fall in the pound?

Last week, the post-Brexit price pressures became apparent as a result of the dispute between Tesco and Unilever. Marmite and various other household brands, such as Hellman’s Mayonnaise, PG Tips and Persil, were removed from Tesco’s website. Unilever, the third largest consumer goods company in the world and the producer of these products, increased the prices charged to Tesco by 10%. The cited reason for this was higher costs. Tesco rejected these higher charges on behalf of consumers and removed Unilever products from its online store. This caused quite a stir in the UK and indicates that higher prices are soon to hit consumers.

Since the referendum in June, the pound has fallen dramatically to new lows. This, in addition to rising commodity prices in dollar terms, has meant rising costs of imported ingredients for many companies, including Unilever. Although this is the first story of this kind to make headlines, it is unlikely to be the last. All companies who import goods to the UK are facing higher costs and are left with the difficult choice between trimming profit margins and passing higher prices onto customers.

In this case, Unilever chose the latter. Tesco decided to reject the price rise and thus faced a backlash when Unilever goods couldn’t be purchased online. The issue has now been resolved but the dispute reminded consumers that Brexit is likely to mean higher prices going forward. After years of price competition continually diminishing margins, retailers like supermarkets are unlikely to have much choice but to raise prices in the long run in the face of the inflationary pressures brought about by the moves in the pound. This means that consumers’ money will be worth less and less in the near future.

 

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