Investors brace for ‘dividend drought’ as companies take axe to payouts

A dividend drought will soon emerge, which income investors need to prepare for. 

At the start of the year dividend payments in both the UK and internationally reached record highs, but they are now set to fall significantly following the coronavirus pandemic.

Dividend cancellations or postponements have been coming thick and fast over the past week or so. Companies taking these measures include DFS, British Land, Halfords, Rentokil, Dunelm, Whitbread, ITV, Kingfisher, M&S, Greggs, Card Factory and housebuilders Bellway and Persimmon.

As a result, a ‘dividend drought’ will soon emerge, which will hit income investors in the pocket. The shortfall will become even worse if the big dividend players in the market – the oil majors, tobacco firms and banks – take an axe to their payouts.

On this front, it was announced (1 April) that the UK’s five main banks – Barclays, HSBC, Lloyds, Royal Bank of Scotland and Standard Chartered –have all agreed to scrap their dividend payments to shareholders. The dividend freeze will ensure banks are better placed to support the economy during the current uncertain economic climate.

According to Richard Hunter, head of markets at interactive investor, the announcement that banks will be suspending dividends “removes a core plank of the case for buying bank shares.”

Before the announcement, all of the main UK banks were on generous yields, owing to the market declines seen since the seriousness of coronavirus became apparent. Lloyds Banking Group had a dividend yield of 10.5%, Barclays 9.6%, HSBC 9%, Standard Chartered 4.9% and Royal Bank of Scotland 4.4%.

Commenting generally on dividend cuts that have been made over the past couple of weeks, Hunter notes: “A score of companies who have already reduced, deferred or cancelled their dividends is ample proof that in terms of financial prudence, the lack of a dividend payment in the short term is already becoming an entrenched feature of UK plc.”

Various fund managers with an income mandate are preparing to deal with the headwind of a notable increase in dividend cuts.

Adrian Frost, Nick Shenton and Andy Marsh, who manage the Artemis Income fund, make the point they would “rather see management preserving the fabric and long-term earnings potential of a company rather than taking measures to support dividends in the short term.”

In other words, the fund managers do not want to see management teams over-reaching by handing back more cash to shareholders than they can afford. Those that do so in order to keep shareholders happy risk damaging both their short and long-term growth prospects, as the money could instead be used to support and invest back into the business.

- Four warning signs a dividend cut is on the cards 

The Artemis team adds in its update to investors: “The possibility of a period of lower dividends for some companies must now be contemplated. Set against that, however, the yield on the UK market at the time of writing (20 March) is hovering around 6%, which would imply that the market has gone some way towards recognising the risks to dividends.

“The measures taken by governments and central banks to cushion the impact of the virus has led to even lower interest rates and this is likely to persist for some time. This has the effect of making equity cashflows and dividends, notwithstanding inevitable reductions, more attractive.

“Although the prospect of lower dividends is a concern, we would point out that our portfolio gains its income from a broad spread of companies. Those dividends are significantly less concentrated by sector than the dividend from the FTSE All-Share.”

However, Alastair Gunn, lead manager of the Jupiter Growth & Income fund, makes the point that “the increase in dividend cuts isn’t just a large cap issue – smaller companies are doing the same in an effort to bolster their capital positions.”

Turning his attention to banks, Gunn’s view is that they should not be paying a dividend in this environment.

He adds: “For many banks, payouts to shareholders are a core pillar of their investment case over the long term, but it is more prudent currently to focus on sustaining their business for the future. While banks continue to generate revenue now, no company is set up to operate in a possible world of zero revenue.

“The government is doing what it can to support the economy and the banking sector has got to practice forbearance as well. If that means withholding dividends then I think that is sensible, especially when you consider banking’s role as the primary transfer mechanism, enabling the wider economy to stay afloat.”

Not just a UK dividend dilemma 

While the UK has historically been a rich hunting ground for investors, over the past decade international stocks have increasingly become more dividend-friendly. International dividends reached a new record of $1.43 trillion in 2019, with an underlying growth rate of 5.4%. 

Global businesses will also inevitably cut their dividends. Jason Pidcock, manager of the Jupiter Asian Income fund, says: “There will be a widespread cut in dividends. I imagine most companies will cut, but there will be a few who cancel altogether and a few who maintain dividends even in the face of lower earnings by paying from a strong balance sheet, probably where they are in a net cash position.

“We have seen a number of companies ‘withdraw guidance,’ which is effectively an admission that dividends will be lower.  However, we have to remember share prices have fallen by some way, and if dividends don’t fall as much, then yields will still look very attractive, particularly in comparison to government bond yields.”

In light of the dividend headwinds, Bruce Stout, manager of the Murray International Trust, notes that “great care and attention must be paid to balance sheets, payout ratios and managements’ previous history of dealing with opaque operating environments.”