British investors face a 20 billion pound dividend shortfall this year as UK companies opt to protect their balance sheets in the global recession.
The slide in earnings caused by crumbling demand is forcing a hard rethink about how much to pay UK shareholders, who traditionally have attached high importance to dividends.
Morgan Stanley expects a 60 percent peak-to-trough fall in UK profits, worse than the early 1930s at the time of the Great Depression.
Analysts say this will intensify downward pressure on yields.
"Dividend distributions are falling. Headline dividend yields are not to be trusted. We think there is more dividend downside ahead," Citigroup said in a note to clients.
The ratio of dividend yields to government bond yields has averaged 1:2 over the last few decades, and analysts have seen a ratio of even 1:1 as a buy signal for equities.
But though one year forward UK dividend yields at 6.4 percent are more than double government bond yields at 3.11 percent, few investors see this as a call to buy stock, partly because many question the accuracy of dividend forecasts in an uncertain environment.
ING sees a 40 percent top-to-bottom decline in dividend payouts with nearly two-thirds of that drop yet to occur, suggesting dividend yields will fall back to 4.5 percent. The overall dividend payment from the UK market will be around 40 billion pounds for 2009, compared with 60 billion pounds ($82.5 billion) last year, ING estimates, but says the risk is that the decline will be bigger.
Pressure on dividends will come from authorities keen to demonstrate that they are putting the public good ahead of shareholder demands, said Graham Secker, equity strategist at Morgan Stanley.
"Regulators and governments will probably clamp down a little more on shareholder-friendly actions so the risk premium is going to be rising," he said.
"Corporate taxes may go up to pay for some of the government's borrowing and that may mean there's less money to give to shareholders as dividends," Secker said.
Ultimately this could mean that investors take their money out of equities entirely and search for their yield elsewhere.
"There's a risk that problems keep building and if they do, you may find equity income investors transfer some of their funds into corporate bond fund-type investments," he said.
SWINGING THE AXE
Companies cutting their dividends include miner Kazakhmys and British bus and train operator National Express.
Shares in BT fell sharply last week after Morgan Stanley suggested the group may cut the final dividend to pay increased top-ups to its pension.
"We were seeing the magnitude of earnings downgrades, but there was a forlorn hope that dividends would be more robust," said Philip Lawlor, chief portfolio strategist at Nomura.
"What we've seen over the last three to four weeks is companies acknowledging that dividends are unsustainable."
HSBC, previously an oasis of solid dividends among battered financials, has already cut its 2008 payout by 29 percent and analysts say there could be furthere reductions.
Other companies with dividends still seen by many as rock-solid may have to axe to their payouts.
BP said that it would keep dividends on hold, but if the oil price stays at the current depressed levels cuts may become inevitable.
"I sense it's hope rather than expectation when they are holding it flat," said Lawlor.
"I suspect it's just suspending. Often the market reaction will tell you it's suspending a cut." BP shares fell 4.3 percent on the day it said it was maintaining its dividend.
In the end, the decision on what dividend to pay is likely to be driven more by the macroeconomic environment than by management preferences.
"There will remain a strong income bias, but it's not going to be setting the agenda, it's going to be the macro fundamentals that determine whether companies will be in a position to pay the dividends," Secker said.
