FTSE 100 defensive dividend-paying stocks have suffered twofold during the two years of higher interest rates.
First, higher rates have weighed on their earnings by squeezing margins due to higher financing costs, and some have suffered due to reduced consumer spending power.
Second, investors have shunned defensive dividend payers in the era of higher rates because they were able to get 4% risk-free in government bonds.
Both of these factors are about the be turned on their heads. The change won’t be dramatic, but it will certainly make these companies’ shares more attractive.
Reckitt Benckiser
Reckitt Benckiser hasn’t traditionally been a huge dividend payer, but recent performance has made the consumer goods company’s yield – now 4.6% – a bit more attractive.
The company sells approximately 30 million consumer products across defined product portfolios: hygiene, health, and nutrition. Reckitts owns a range of household names, including Air Wick, Clearasil, Dettol, Durex, and Neurofen.
Reckitt Benckiser has been hit by consumers opting for cheaper alternatives amid the cost-of-living crisis, and volume growth hasn’t been great. They’ve been forced to increase prices to fight input price inflation, and this has just about offset higher costs. Operating margins fell 30bps in the first half of 2024, and investors jumped ship.
Although Reckitt’s volumes grew over the first half of 2024, Q2 saw a volume decline of 2.2%. Revenue was flat during the period, and this has been reflected in the share price, which is now down 21% year-to-date.
We do not assert that this trend is completely finished or that it will reverse anytime soon; rather, we suggest that it is unlikely to get much worse for Reckitt Benckiser.
With sentiment around the stock near rock bottom, it’s likely most of the investors who were keen to sell the stock have done so, leaving a clear path for recovery in the share price as buyers tip-toe back into the company.
Lower interest rates will put more money back into the pockets of consumers who may return to branded household goods as confidence returns. This is key to any Reckitt Benckiser investment case.
United Utilities
As a lower beta water utilities company, United Utilities is as defensive as it comes. There are concerns about potential regulatory action due to the dumping of sewerage into waterways that may cap gains, but any action is unlikely to materially affect the long-term Investment case.
With a 4.9% yield, the stock has an adequate dividend to compensate for any lengthy waits for capital appreciation.
During times of heightened volatility and economic duress, investors flock to utility companies to avoid the wild ride some cyclical shares can experience. United Utilities would be a beneficiary in such a scenario. Lower interest rates are also likely to help the company.
Despite UU’s reliable income, there is little opportunity for major growth. The amount it can charge for the treatment and distribution of water is heavily regulated, and any major movement to the top line is unlikely. Revenues fluctuated by around 2% between 2022 and 2023.
The dictator of United Utilities’ profits is everything that comes below top-line revenue – finance costs being a major factor.
The group experienced a sharp uptick in its finance costs between 2022 and 2023 as interest rates rose, eroding profitability.
One would expect this to reverse as interest rates fall and help bolster United Utilities’ dividend. Investors should watch the company closely for any dips relating to regulatory action and use dips as a potential buying opportunity.
Shell
We understand Shell’s suggestion isn’t amazingly original, and it’s not particularly defensive, either. However, investors are able to pick the stock up with a 3.7% yield at current prices that offer a reasonable probability of capital appreciation over the medium term.
Oil prices have slipped back on concerns about global growth and taken Shell shares with them. Investors have become desensitised to ongoing geopolitical risks, and the windfall provided to oil majors such as Shell has all but disappeared.
That said, although recent results revealed a drop in Q2 adjusted EBITDA compared to Q1, EBITDA for the first half of 2024 was broadly in line with the first half of 2023 – despite significantly lower oil prices.
Shell remains a cash-generating machine and is fully prepared to distribute this cash back to shareholders through regularly increasing dividends. The group generated $10bn free cash flow in Q2, higher than in Q1.
Strong cash flow enabled Shell to increase its dividend to $0.688 over the first half of 2024 compared to $0.6185 in 2023.
In addition to the dividend, Shell provides investors with a holding that can move favourably in times of increased global tensions, such as those we are currently experiencing.
The interest rate story is heavily intertwined with oil prices and, therefore, Shell, from the demand side of the story. US growth wobbles are playing a big part in lower oil prices. Conventional thinking around lower interest rates would suggest incoming rate cuts will boost overall growth, providing support for Shell.
There have been rumblings Shell is considering a switch to US markets to achieve a better valuation. While this would be a real blow to London and is far from a certainty, it does highlight the deep value in Shell shares compared to US peers.