Europe dividend outlook set to close gap with U.S.
* European dividends priced for contraction
* U.S. dividend futures implying 10 pct growth
* Ex-financials Europe dividends seen growing
* European earnings forecast to remain stable
By David Brett
LONDON, July 23 (Reuters) - The ballooning gap between expectations for future U.S. and European company dividend payouts could be set to close as the market has priced in a much gloomier scenario in Europe than justified by current payouts and earnings forecasts.
Expectations for payouts in Europe have crumbled on mounting concerns over global growth and corporate earnings, and the region's dividends are now priced for steep contraction of 15 percent over the next four years and no growth after that.
By contrast, U.S. payouts are expected to grow around 10 percent over the coming four years.
But some say the European outlook is too gloomy.
"The slope of the European dividend maturity curve suggests a bearish interpretation of future dividends to come from banks, telecoms and utilities, which we find overdone," Barclays European equity strategist Edmund Shing said.
The bearish pricing of European dividend futures - which track the payouts from all the companies in the Euro STOXX 50 index during a calendar year and convey exposure to dividends rather than to share prices - re f lects concerns about the euro zone crisis and the relative economic health of the two regions.
But some analysts say the gap with the United States is starting to look unjustifiably wide, not least because U.S. economic data remains patchy, at best, and with top U.S. firms, including Xerox and Ebay, issuing profit warnings.
Across all business sectors, average dividend payouts in Europe are running at around 42 percent of earnings, far higher than the 33 percent seen in the United States, which means investors in Europe get a bigger slice of the bottom line.
Financials, telecoms and utilities - the biggest euro zone dividend payers - are handing out more than their five-year average. The dividend yield, which measures a company's payout relative to its share price, on the Euro STOXX 50 is 5.3 percent, compared with S&P 500 companies on 2.6 percent and negative real yields on government bonds.
European payouts may even pick up, as cash-rich companies baulk at investing in new factories and hires, given the weaker backdrop, and instead look to keep investors sweet by passing on excess profits.
"In the non-financial sectors you might even see an uptick in dividend ... Equities are not capital stocks for the next few years through fear of deleveraging, so with the outlook for growth the way it is you might as well pay out your earnings (to keep people investing)," said Robert Quinn, European strategist at Standard & Poor's equity research in London.
The prospect of a shift in the European dividend outlook may create trading opportunities.
When the spread between U.S. and European dividend expectations gets particularly wide, investors look to sell exposure to U.S. payouts and buy those of European companies via the futures market.
"You could buy Europe and sell U.S. if you wanted to do a hedged trade. That would probably make a decent profit," Tristan Hanson, head of asset allocation at Ashburton, said.
Ashburton, which has around 1.1 billion sterling ($1.7 billion) under management, has been investing in long-dated Euro STOXX 50 dividend futures, from 2016 to 2021 , which they think are trading at unjustifiably cheap valuations.
Part of the reason for the anomaly is due to the popularity in Europe of so-called structured products, which offer exposure to the stock market but with limited risk.
These do not usually include dividend exposure, which the structured product provider tends to sell on via dividend futures, pushing down prices through over-supply of the longer-dated maturities.
"Europe's got a depressed economic outlook which in itself is putting downward pressure on dividends. In addition, structured product flows are also applying further downward forces on European dividend future prices," said Simon Carter, head of European equity derivatives options research at Deutsche Bank.
"In the U.S. you have a stronger economic backdrop pushing up dividend growth expectations. Variable annuity fund hedging activity also acts to push up longer-dated U.S. dividend futures, which causes the dividend growth curves in the U.S. and Europe to align in opposite directions," he said.
But the discount still looks very steep compared to earnings expectations. Looking at current share prices and forward earnings per share, the market is implying a compound annual earnings contraction of 3 percent in developed Europe over the next five years, compared to growth in the United States of around 3.6 percent.
"The market needs to absorb a little earnings and corporate disappointment in the first half (of 2012) because of the slowdown, but I think overall the outlook for earnings is reasonable and the outlook for dividends even better," Richard Jeffrey, chief investment officer at Cazenove Capital Management, said.
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