Wellian Weekly 20.04.2020

Dividend Sustainability

For income investors it’s been a torrid time; the ‘perfect storm’ doesn’t even begin to describe the situation we are going through. Across the board, dividends are being cancelled – with some yanked just days before payment. As you’d expect, the FTSE 100 is doing slightly better than the UK-focused FTSE 250, but only slightly.

For savers the Bank Base Rate is now just 0.10% – a fifth of what it was even during the dark days of the financial crisis - so it’s no surprise that savings accounts are paying rates of 0.01% and 0.05%. UK fixed-income yields are on the floor, but at least they’re still positive, unlike yields in a number of many other countries. For property buy-to-let investors, you hear of landlords whose tenants have either been laid off or furloughed, and so can’t pay the rent. So equities remain the only game in town for many income investors who are seeing vast swathes of the UK’s listed companies cancel their dividends amid the crisis.

The wide-ranging cancellation of dividends is of the levels that we haven’t seen or experienced the likes of before. Reports have tallied £28.2bn of dividend cuts in the UK so far this year.

The number of companies making dividend cuts is being carried out across the whole market and has really brought home the scale of the dividend retrenchment as many companies see huge amounts of uncertainty ahead and are taking a number of measures to conserve cash.  Even companies that appear to have the capacity to pay out and where they know dividends are extremely important to shareholders are cancelling.  On the face of it, financial prudence is the reason even when the revenues and profits of some companies are set to hold up relatively well over the period. It would also be politically difficult for companies which are using the governments furlough arrangements to pay dividends, as the Treasury would probably not be very happy to be providing financial assistance on the one hand only to see cash paid out as dividends on the other. For this reason, dividend payments are only likely to resume once these companies are free of government aid.

There are some suggestions that dividends across the UK market will be reduced by 30%-35%, but this has the feeling of being far too optimistic as FTSE futures are suggesting it will be more like 50%. At a sector level, the banks, which were likely to have paid more than 8% of the FTSE’s dividends this year, have been left with no choice but to obey the request of the Bank of England’s Prudential Regulation Authority and have been told not to pay their dividends while the country is in lockdown despite being in good health. The miners, which paid out large dividends last year, will reduce their payouts to the effect of knocking 4% off the market dividend because they pay a percentage of earnings as a dividend and these are going to be reduced by at least 30% this year.

The two largest dividend payers in the FTSE, Royal Dutch Shell and BP, which now account for nearly 30% of the index total dividends, are both currently still paying. Both have reduced capital expenditure and operational expenditure over the last few years since the last oil price collapse. But with yields in excess of 10% and thin dividend cover their payouts will be scrutinised over the coming months. It could be a good time, like it would be for many other companies, to have their dividends rebased to a lower starting point. If they halved their dividends this would knock another 10% off the FTSE dividend total, but Royal Dutch Shell will want to keep their track record of not cutting their dividend since World War II.

Eventually, all this will pass. In the meantime investors must prepare themselves for an uncomfortable few month’s as the recovery could be lengthy. Yes, there are apparent bargains out there; but for income investors, judging a company’s dividend sustainability is going to be tricky.

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