High utility dividends are bad for Britain’s infrastructure
Companies such as BT are not investing as much of their earnings as they should
Why do private utilities pay such high dividends? And, more importantly, does it matter if they do?
Britain’s stock market is awash with such companies, ranging from the energy group, Centrica, which yields a princely 9 per cent, to the telecoms group BT, which returns a still pretty chunky 6. All the remaining listed water companies, from United Utilities to Severn Trent, are on above market yields.
In theory, companies only pay high dividends as a last resort: when they cannot find more attractive homes for their capital. In declining sectors, for instance, that might reflect declining opportunities for reinvestment. Some utilities, such as Centrica, arguably fall into this category, facing the long term eclipse of their core thermal energy businesses because of environmental concerns.
But super-dividends don’t just happen in sunset sectors. And they are particularly prevalent in highly regulated monopoly industries, especially those where prices are subject to periodic review.
There is a certain debased logic to this. For when a watchdog sets your allowable returns, there’s always the worry that any gains (particularly fat ones) might not be permanent. The best way to avoid the possibility of regulatory clawback is simply to yank the money out.
Then there are self-inflicted high yields, where investors lose confidence in the managers, especially those which seek to diversify steady utility businesses into sexier, faster-growing activities.
Take BT, which has invested heavily in businesses where it has no evident competitive advantage, such as the exploitation of costly TV rights for sporting events. Lack of confidence in the strategy has combined with concern about the company’s £14bn pension deficit to make investors keen on taking the cash out where possible. The result? A stock yielding 6 per cent.
High dividends have become controversial, especially in essential services such as water and energy. The public resents high payouts that result from lax regulation allowing financial engineering and regulatory arbitrage, rather than better services to them.
But are high dividends a symptom of something even more insidious? Do they actively damage the quality of the services the public receives?
They can, according to the economist Dieter Helm. In a recent paper, he argues that a tendency to over-distribute reduces the capacity of utilities to serve their customers. It is also counterproductive, ultimately eroding the equity returns available to make those payouts. That’s because companies with high yields tend to get caught in a dividend trap.
Increasingly beholden to income investors, managers are under pressure to maintain payouts, even at the expense of forgoing profitable investment opportunities. After all, to impose a cut would probably mean forgoing a well-paid job.
Take BT again. The company might have splurged on sports rights, but it has neglected to invest in its core network, for instance replacing copper wires with high-speed fibre to carry internet services to its customers. Rather it pursues the low-risk stratagem of relying on its incumbent position and customer inertia to milk every last penny from of its historic network, using Heath Robinson technology to supply broadband services of inferior speed and quality.
This isn’t great for BT’s shareholders in the long term. But, as Professor Helm points out, the real damage is to the wider economy. “Britain has gone from a leader in communications, following liberalisation back in the 1980s and 1990s, to a laggard,” he says.
So if high dividends are the problem, what is the answer? Fat payouts tend to flourish in sectors where cash flows are very stable — largely because of the absence of competition. Attempts to synthesise competitive discipline by regulation in monopoly sectors have been too easily gamed.
Competition should be sharpened. It remains a mystery why the UK government has not broken up BT, separating fully the Openreach network business, and thus opening its system to those who wish to invest in fibre services. This would be far more beneficial to the economy (and far cheaper) than the highly expensive HS2 high speed railway.
It would also reverse BT’s spiral of skimped investment and high dividends, encouraging the network to reinvest more of its earnings.
Whether meaningful competition can be introduced in monopolies such as water remains uncertain. Prof Helm believes it can if the state adopts a new approach, simply setting the outputs it wants (new sewers, flood defences, etc) and then opening those plans to competitive tender rather than relying on incumbent operators.
But whatever the conclusion, inertia is not an option. The current regime works poorly for the public. Privatised public service utilities must do things differently, or risk re-absorption into the public realm.