Dividend cuts firm as companies sandbag balance sheets
Payouts are tipped to fall as much as they did in the global financial crisis, but they may rebound faster.
Investors should brace for a sharp fall in dividends as companies look to shore up their balance sheets to offset the fall in profits caused by the coronavirus crisis.
Asset managers say the fall in economic activity is likely to be at least as large as in the 2008-2009 global financial crisis, but for a shorter period of time.
And while the dividend cuts are likely to match those of the GFC they are unlikely to last as long.
During the GFC, almost two thirds of companies reduced their dividends and a further 3 per cent suspended them completely, says Michael Price, portfolio manager of the Ausbil Active Dividend Income Fund.
“The peak-to-trough fall in dividends per share was 33 per cent, as new share issuance further diluted the yield received by existing shareholders.”
Price says that at this stage it appears the fall in economic activity is likely to be at least as large as in the GFC but won’t last as long.
The amount of government and central bank stimulus already exceeds that of the GFC, which Price says may allow most companies to survive the downturn without having to issue additional capital that permanently dilutes the earnings and dividends for existing shareholders.
“So, while dividends may fall just as much, it is quite possible that they rebound faster than after the GFC,” Price says.
“As an example of this, we have already seen more companies suspend their dividends than occurred during the GFC. This indicates that dividend cuts could be quite severe but are expected to be more temporary.”
At this stage it appears the fall in economic activity is likely to be at least as large as in the GFC but won’t last as long, according to some asset managers
Joanna Nash, portfolio manager at systematic manager Acadian Asset Management in Sydney, agrees dividends will be cut as companies tighten their belts.
“Dividends are likely to be cut as companies focus on balance sheet strength during the reduced economic activity rather than maintaining payout ratios,” Nash says.
“The current yield (dividend/price) on the ASX200 has jumped by approximately 1 per cent since the end of 2019 which has been driven by the fall in the stock prices not by an increase in dividends.
“Once we know more about the impact of COVID-19 we are likely to see this yield fall and the yield should stabilise back towards its long run level of between 4 – 5 per cent.
Morningstar banking analyst Nathan Zaia last week suggested investors in the big four banks should brace for a hit to dividends.
“We caution there is elevated risk around near-term dividends and investors should not expect a steady income stream,” Zaia said.
“Our earnings forecasts are reduced between 5 and 10 per cent, and dividend forecasts are reduced up to 17 per cent on the assumption payout ratios also fall.”
Acadian’s Nash says that while the coronavirus is hitting all parts of the economy it is doing so in a different way and that dividends “may be lower for longer”.
“The GFC played out over a longer period starting initially in the banking sector and then spreading, whereas COVID-19 has hit all sectors of the economy at once.
“In this crisis we are seeing many businesses effectively shut down or hibernate for a period of time. The length of this shutdown period will affect how long earnings will be impacted.
“It also takes longer to recover than to fall, so it is likely that dividends may be lower for longer as balance sheet strength takes priority during reduced economic activity.”
Longer-term outlook for dividends
Despite the forecast fall in dividends, it is no time to exit the equity market, Ausbil’s Price says.
Investors must accept the short-term hit and remember that relative to other investments, the income from shares is “likely to remain very attractive”.
Nash agrees that investors who hold shares for both long-term capital growth as well as income will suffer in the near term.
However, she advises investors to focus on their long-term goals, consider rebalancing their portfolio, and avoid yield traps, referring to the pitfall of investing in company that pays a high yield but is structurally shaky.
“While there does look like some good buying opportunities when investors focus on the current yield levels, we have seen a number of companies in the past weeks suspend or cancel their previously announced dividends.
“This trend is likely to continue as companies report their full-year results and we see the impact on earnings over the next couple of months.
“Investors at this time need to be very wary of falling into the yield trap. Due to the large fall in stock prices, many stocks have a very attractive historical yield which will not necessarily be reflected in the second half of the year.”
Morningstar director of personal financial Christine Benz notes that while suggesting rebalancing is simple, implementing a rebalancing plan is less so.
“Largely because it entails selling appreciated securities, which may trigger a tax bill unless you're careful,” she says.