Not only is there increasing chatter that the Bank of England might have finished increasing interest rates, but there’s talk of potential interest rate cuts next year. This could become a reality if inflation continues to moderate and if UK GDP (gross domestic product) growth contracts. In this eventuality, here are some dividend stocks that I think could do really well.
Benefitting from lower borrowing costs
A key area that could outperform would be real estate investment trusts (REITs). These companies invest in commercial and residential properties and use the tenant lease/rental income to pay out to shareholders.
When interest rates rise, this is bad for REITs. Raising new debt to fund projects is more expensive. Further, tenant demand is lower as many have to contend with cutting back on expenses.
So if we see this flip next year with lower interest rates, I think REITs could outperform. This would help investors in two main ways. Dividend-per-share payments could increase, based on higher occupancy rates. The other addition would be that the share price should rally to be closer to the net asset value (NAV) of the properties.
Two firms that tick the boxes from my perspective right now are Land Securities Group and Primary Health Properties. The current dividend yields are 6.48% and 7.12%.
One point to flag up is that there may be a time lag from interest rates falling to property companies benefitting, as it’s not an immediate impact.
Income and a defensive play
The other area that could do well for income is utility companies. The two that are on my radar are United Utilities and Severn Trent. The current dividend yields are 4.26% and 4.03% respectively.
Usually, utility firms carry a high level of debt. This is because the capital projects are large and expensive, so are funded by borrowings. For example, Severn Trent has a debt-to-equity ratio of 7.42!
High interest rates put pressure on firms with large debt piles, but if this gets reduced next year, it could significantly help things. Investor sentiment should become a lot more positive about these stocks, thanks to better free cash flow levels.
It should also aid the dividend payments as the dividend cover will likely increase. Both companies are defensive shares, meaning that it could help to protect the rest of my income portfolio if we get a stock market crash.
The risk is that even with lower interest rates, the high debt piles are going to be a problem for years to come.
I’m going to wait for some clearer signs in coming months about the future direction on interest rates in 2024. But if and when I get confident about cuts, these are four stocks that I’ll be buying.
