April 11th, 2013
Why is the UK doing so badly and what does this mean for shares going forward?
Is the FTSE100 heading for a massive turning point?
Company results and dividends
For investors in UK companies with a large portion of sales coming from international sources, such as Vodafone, British American Tobacco, WPP, BP, BHP Billiton, Astrazeneca, Pearson, HSBC, Unilever and ARM Holdings, the economy in the UK continues to damper enthusiasm among many investors.
Given the similarity between the USA and the UK in terms of the structure of the economy and the past performance of both nations, the obvious question is, 'How is the UK doing compared with the USA?'
Despite a vast budget deficit of nearly 7% of Gross Domestic Product (GDP), a nearly 30% fall in the pound sterling, very low nominal and real interest rates, and nearly £390 billion in quantitative easing, the UK is barely staying out of recession.
The government is now forecasting GDP growth of 0.6% this year, and in the near term, the UK economy looks like it could be heading back into a third shallow recession based on the 1.2% decline in industrial production last quarter. Unfortunately for the UK, with inflation running above the Bank of England's target of 2%, there is little more policy makers can do to stimulate the economy without stoking further inflation.
While all economic data is subject to some degree of uncertainty, by almost all measures, the USA is doing better than the UK.
What is causing these issues?
Why is the UK doing so badly and what does this mean for British shares going forward? There seem to be three major factors weighing on the British economy currently. The first two are widely recognised, but the third does not seem to be discussed much.
First and foremost, Great Britain is closely connected with the fortunes of Europe, and with Europe doing so badly, the UK is in trouble as well. This is partially offset by the weakening pound sterling (which is itself primarily a result of concerns over future weakness in the nation's economy), but the effect of a weak Europe is still significant for the United Kingdom.
While the USA is historically the biggest export market for British goods, the next seven largest markets historically are all various European countries. With the broader European economy looking anaemic at best, it should be no great surprise that British manufacturers are exporting less than they did in the past.
While it is unquestionably clear that a declining pound sterling has helped, the data indicate that the demand crunch for UK exports has been much larger than the benefit from a lower currency value. The result has been a fall in net exports.
Secondly, the austerity program the government have enacted is definitely hamstringing the economy. To the extent that austerity programs have any beneficial effects for an economy, the benefit will primarily be felt through two mechanisms: less crowding out of private investment by government investment and greater confidence in the fiscal future of the nation leading to lower cost of capital and higher levels of business activity.
Unfortunately neither of these effects is an issue for the UK currently. Private investment is currently very limited due to concerns about the economy, and as a result, there is very little crowding out occurring as evidenced by the extremely low interest rates the UK faces. Further, the concerns over the future of the economy seem to be causing significantly more loss of confidence than the austerity is providing.
Third, the UK as a whole and London in particular, may have a structural employment issue. Historically London was a major financial center, and while it is still one of the most important financial capitals in the world, finance as a contributor to global GDP has fallen markedly. Nowhere is this more true than in Europe, and as a result, many British banks have laid off large numbers of employees.
In essence, Britain shares something in common with Cyprus here; both economies depended heavily on finance as a source of employment and national GDP. Now fortunately for the UK, our economy is nowhere near as dependent on finance as the Cypriot economy was, but nevertheless with the financial sector having shrunk rapidly in the last few years, it is inevitable that the Brits would be left with too many bankers and not enough engineers, doctors, and other skill occupations.
So what does this mean for British shares?
It is likely to mean that the national overhang associated with those companies with large foreign revenues is likely to continue until one or more of the above issues is resolved (and all of them look likely to take a while to work through). The companies that are most exposed to the weakness in the British economy are those that do much of their business domestically.
Is the FTSE100 heading for a massive turning point?
With the FTSE100 heading for 6500 are we slowly but surely getting into the ‘danger zone’?
With two previous turning points ate 6951 (30 December 2000) and 6751 (18 June 2007) will we be seeing a major downturn later this year?
Watch out for the next edition of Dividend Alerts when I will take a closer look whether a major downturn is just around the corner.
Company results and dividend announcements
The big news, since the last Dividend Alerts, were the rumours that Vodafone may be entering some form of transaction which would allow it to cash in on its 45 percent stake in US mobile telecoms giant Verizon Wireless.
I have extensively written about the prospect of deal at Vodafone, Here, and more recently (2 April 2013) Here.
First Group issued a trading statement for the year ended 31 March, ahead of full results due out on 22 May. They say that trading is in line with expectations and are confident that the actions they are taking will position the business to generate sustainable growth and improved returns.
While the interim dividend was held at last year's level, following the uncertainties created by the government's shambles over the rail re-franchising a dividend cut is forecast by many analysts for 2013 over the 23.67 pence paid in 2012. The worst forecasts are around 17 pence for 2013 followed by a further reduction to 13 pence for 2014.
ICAP also released a trading statement in advance of full year results with some uninspiring news. The company re-confirmed that conditions for the nine months to 31 December were extremely challenging but the increased activity levels seen in January and February have not continued at the same rate into March. This will result in revenue down by 13% and pre tax profits of around £280m, in line with the lower end of earlier guidance.
Against this background, their cost saving programme has delivered as forecast making the company, they say, a more efficient organisation. Together with investment in the business, ICAP expects that this will continue to drive growth over the next two years.
The dividend forecasts for the current year to March 2014 and the figure for the 2013 year just ended are barely above the 2012 actual of 22.0p, due no doubt to the lower profit levels.
National Grid announced their new dividend policy from 1 April, together with a trading update. The former is of most interest to us and they say that their aim is to grow the dividend “at least in” line with RPI inflation for the foreseeable future. Any dividend increases above inflation will need to be supported by sustained outperformance and to have no impact on their long term credit ratings. The 2014 dividend forecast is 41.8 pence.
I have commented extensively on National Grid’s rather disappointing dividend prospect in an recent article (5 April 2013) that you can access Here.
Fellow utility SSE published a trading update ahead of annual results to 31 March which they say will be solid. They confirm that the 2013 dividend rise will be at least RPI+2%, making a full year total of about 84p. In comparison to National Grid, SSE’s target for the current regulatory period from 2013/14 is to deliver RPI+ annual increases. The 2014 dividend forecast is 86.8 pence.
AstraZeneca published an extensive document outlining their strategy for a return to growth. I have extensively commented on AstraZeneca’s progress, the most recently in an article on 2 April, that you can access Here.
From a dividend pay-out perspective, AstraZeneca remains committed to maintaining a progressive dividend policy under which the payout will be held or grown with a target cover of twice core earnings over their investment cycle. This would suggest that the dividend won’t be cut. The 2013 dividend forecast in sterling is 191.5 pence per share.
With the FTSE100 heading for 6500 is now the time to buy shares?
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