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 Global miner Rio Tinto raised its dividend by 15 percent last week,
and French oil firm Total joined in with a 3.4 percent rise, while
French bank BNP Paribas said it planned to boost its dividend payout
ratio to around 45 percent of earnings by 2016 from 41 percent.
That would have been welcome news to those who ploughed more than $1
billion into European dividend funds in January, the biggest monthly
sum since the middle of 2011, EPFR data showed.
Investors have been lured to these funds by predictions that
aggregate dividend levels in Europe will return to growth this year
after holding flat for two years.
According to Markit data, dividends for MSCI Europe (ex-UK)
companies will rise 5 percent to 183 billion euros ($250 billion) in
2014 and to almost 200 billion euros next year. More than half of
the firms are expected to raise dividends this year, with only 13
percent seen likely to cut.
Investors have therefore pushed Euro STOXX 50 dividend futures for
2014 and 2015 up 2.6 percent and 4 percent, respectively, this year,
Thomson Reuters data shows.
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However, shares in defensive sectors like telecoms and utilities
that generally pay good dividends could underperform the wider
market as higher debt levels, further infrastructure investments and
a possible rise in acquisition activity hinder their ability to
return cash to investors, analysts said.
"In a negative real interest rate environment, dividend-paying
stocks perform well as people flock for income. The first place
investors have gone for dividends is defensive sectors," said James
Butterfill, global equity strategist at Coutts.
"But some defensives are quite expensive now, and we are not sure
how sustainable their dividends are, particularly utilities and
staples."
The ability of the telecoms and utility companies to pay rich
dividends could come under stress as their dividend cover — the
ratio of earnings to payouts — hovers at around 1.5 times against a
long-term average of 2.0 to 2.5 times, according to industry
figures.
In contrast, the ratio for information technology and energy sectors
are at 3.9 times and 2.5 times, respectively. Analysts said a
dividend cover ratio of 2 or higher suggests a company is in good
financial shape to pay dividends, but a level below 1.5 indicates
that it might struggle to maintain payouts.
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"Watch out, if you care about dividends, that you don't end up in
certain sectors. We warn about the strategy that says always pick
companies with high dividend yields because they normally
outperform," said Ronny Claeys, senior strategist at KBC Asset
Management. "If you end up in telecoms and utilities, you end up
with sectors having low or no growth."
"Dividend cover is a problem for telecoms, and cutting capital
expenditure in the sector seems difficult," he added
Analysts said stocks in these sectors had become richly priced, and
disappointing earnings could send investors running for the exit.
"The only strong argument to buy these companies is high dividend
yields. But if they decide to reduce dividend payments, there is no
reason to buy or hold them," said Christian Stocker, equity
strategist at UniCredit in Munich.
"Telecoms and utilities have become very expensive, and probably
their earnings will also disappoint. It's better you start looking
somewhere else to maximize your returns."
According to Thomson Reuters StarMine data, telecom and utility
companies on the STOXX Europe 600 index are expected to report a
drop of 29 percent and 25 percent in fourth-quarter earnings from a
year earlier, against a likely drop of 9 percent for the broader
index.
Sectors that could get a boost from dividends include energy and
healthcare, which have good dividend yields and above-average
dividend cover, analysts said.
Drugmakers are in better shape due to their strong product pipeline,
while a cut in capital expenditure by energy firms will help them
amass cash and pay higher dividend, they added.
"Buy cheaper sectors such as energy and healthcare which have
well-above-average dividend cover and continued dividend growth. On
the top of that, they have high dividend yield too," said Coutts's
Butterfill
(Editing by Will Waterman)
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