Dealing with the dividend downturn

By Tony Kaye, Senior Personal Finance Writer, Vanguard Australia

The latest Australian corporate earnings reporting season is now underway, and it’s widely expected many listed companies will announce cuts to their shareholder dividend payments.

This should not really come as a total surprise to equity investors. While the full impact of the COVID-19 pandemic on company earnings will be unfolding for some time, it has already upended the global economy and forced many listed Australian companies to close key operations.

In response banks and other financial institutions have needed to provide tens of billions of dollars in support, including business and household loan deferrals, which has placed unprecedented strain on their own cash flows.

Reflecting this, last week the financial regulator APRA (the Australian Prudential Regulation Authority) announced it was allowing banks and insurers to reduce their dividend payout ratios in view of the severe balance-sheet stress caused by COVID-19.

APRA said banks in particular should seek to retain at least half of their earnings when making decisions on capital distributions, and to use dividend reinvestment plans and other initiatives to offset capital dilution from dividend distributions where possible.

In other words, the regulator has effectively given banks the green light to cut their dividend payouts in order to maintain their required capital adequacy ratios.

What does this mean for investors?

Australian equity investors already had a taste of what’s to come at the end of April when three of the four major banks reported their half-year results.

At the time NAB announced it was cutting its interim dividend payout by 64 per cent, while ANZ and Westpac both advised they were deferring their dividend decisions until further notice.

On a global level, most dividend reductions and suspensions in recent times have been concentrated in the consumer discretionary sectors such as carmakers and other products manufacturers, retail groups, media and entertainment, and the hard-hit travel and leisure sector.

Industrials also have been impacted, with transport companies representing a large portion of dividend cuts.

In the latest Australian earnings reporting period, along with those in the sectors described above, it’s reasonable to expect other companies under financial stress will suspend or reduce their dividend payments to preserve working capital and maintain solvency.

Reductions in dividend payments are most likely to be concentrated in industries without a large technology presence and those relying heavily on having physical space to conduct their business.

Even companies under less financial stress may opt to retain cash on their balance sheet for other reasons, such as to have capital on hand for future needs including opportunistic acquisitions.

Boards also will be under pressure to reduce dividend payouts to shareholders to offset any potential for negative publicity arising from a company having downsized its workforce during the latest crisis.

Some companies will buck the trend

On the flipside, there also will be many companies that decide to maintain their dividend payments.

These will most likely be the long-established companies with dominant or niche positions in their industry, less volatile earnings, relatively high returns on their assets, and low debt-to-equity ratios.

Companies in this position will generally have strong enough balance sheets to navigate through the tough economic conditions without altering their dividend policy, and will have consistently paid and increased their dividends over time.

Other companies may not want to jeopardise their attraction to investors as consistent dividend-paying stocks, especially in an environment where stable income streams are becoming harder to find and where record low interest rates have resulted in lower yields from other asset classes.

Maintaining their dividend payouts will increase investor demand for their shares.

What should investors do?

With dividend payouts from many companies under threat, investors should really be looking at their equity holdings from a total return perspective.

That means viewing companies in terms of their business prospects and the likely longer-term growth in their share price (the capital return) in addition to the dividend income they provide along the way.

It’s also important to ensure your total portfolio remains aligned to your investment strategy and overall risk profile, taking into account your current and future capital needs.

Our recent article, How to rebalance your portfolio out of COVID-19, provides some useful tips on reviewing your investments framework.

All investors should be remaining disciplined in uncertain times such as these.

Forsaking a well-considered, long-term financial plan, rather than staying the course as conditions eventually improve, may cause lasting harm.

What’s important to recognise is that despite the current conditions and the shorter-term impact on dividend policies, investors mostly have experienced gains for the last decade and have been well rewarded over the long term.