China's diminishing demand for commodities will impact UK dividends


China's diminishing demand for commodities will impact UK dividends

One of the great benefits of income investing is the valuation discipline it naturally incorporates into the process by looking/screening for companies that possess a high dividend yield.

Value investing has been proven to, on a long-term time horizon, generate strong returns.

Despite these apparent benefits, UK income investing has been a style that has come under scrutiny as we have witnessed a sustained period of underperformance.

One potential reason for this underperformance is we have experienced a period where a number of companies have been paying out too much income and not reinvesting enough into the business to fund future growth and, in turn, dividends. This may well reverse if and when growth in capital spending kicks in.

A sector that some cite as being guilty of underinvestment is consumer staples. The names that sit here do not worry us as much.

These are mature businesses, in mature industries, that rely on stable and predictable earnings. As such, they can typically rely on incrementally growing both earnings and dividends hereon.

Areas of the market that worry us are miners and oil producers. The earnings of these capital intensive companies are, arguably, neither predictable nor stable due to their underlying reliance on volatile commodity prices and the macroeconomic environment.

One particular risk has bubbled up in China - more specifically, their commitment to move to sustainable and quality economic growth. Long term, this is a positive for the economy.

But looking shorter term and moving away from their previously adopted debt-fuelled growth has significant implications for companies exposed to commodities.

China's proportion of global demand for commodities is staggering, and its demand is a key driver for its markets.

According to the World Economic Forum, China's global share for aluminium and copper demand sits at 47% and 50% - its economy makes up about 15% of the global economy in comparison.

If, and when, Chinese demand for commodities starts to diminish, this will inevitably have significant repercussions on the top-line of these mining and oil producing stocks.

This puts dividends under pressure and is a reason why we should monitor the Chinese economic transition closely.

Sam Buckingham

Investment Analyst

Commentary first appeared in:

Investment Week (on the 2nd May 2018)

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