Shell became the latest company to cut its dividend last week. Can investors rely on dividends returning?
- Around half of UK companies have sliced their dividends in response to the crisis and many more may follow
- Dividend cuts divide into ‘precautionary’, ‘political’ and ‘terminal’
- Equity income managers will need to show flexibility to meet investors’ needs
These are tough times to be relying on dividends for income. Last week saw Royal Dutch Shell, the UK’s largest dividend payer, announce that it would be cutting its dividend by two-thirds to conserve cash amid a falling oil price. Around half of UK companies have sliced their dividends in response to the crisis and many more may follow.
In assessing the impact of these cuts, it may help to divide those companies cutting dividends into three types. The first are those taking precautionary cuts. These are companies such as Direct Line, which has a strong balance and could pay a dividend but doesn’t have strong visibility on earnings and is therefore, sensibly, conserving cash for the time being. These dividends look set to bounce back relatively quickly when ‘normal’ life resumes.
Then there are those companies where government support has made dividend payments politically uncomfortable. The banks, for example, have been discouraged from paying dividends. Instead, they have been encouraged to divert capital to their balance sheets in the expectation of a wave of bad loans. In the EU, there have been outright bans on companies paying dividends where they have been given equity injections by member states. There are also limits on buying back shares or paying bonuses.
These companies may take longer to resume dividend payments. Governments have long memories and even where there has not been an outright ban on dividends, companies are unlikely to be allowed to forget they have had state aid.
The final area are companies experiencing genuine distress. Hotel and leisure chains have no clear route back to profitability. A number will, undoubtedly, go to the wall and even where they survive, it will take a long time for dividend payments to resume.
What does this mean for those who rely on income from shares? Certainly, they will have to be more discerning. The bog-standard equity income manager who relies on a handful of blue-chips to provide income will struggle. Those managers who look across market cap and sector will be in a better position. Equally, it makes the case for global income. The UK market remains concentrated in a handful of sectors, whereas bringing in Asian or even frontier markets can create much-needed diversification.
In many cases, dividends won’t simply bounce back. There may not be sufficient cash flow, or it may be too politically sensitive. Investors need to find flexible managers willing to roam across sectors and countries to deliver a reliable dividend stream in today’s environment.
