Can the pandemic lead to more sustainable dividends?

10 Aug 2020

Shareholders stung by dividend cuts should not expect an immediate recovery.

Equity investors who pocketed less cash in the second quarter after a raft companies cut or cancelled their dividends should not expect the level of shareholder returns to recover quickly. Underlying dividends paid by UK equities halved to £16bn in the second quarter compared to the same period a year earlier.

This was the result of 176 companies cancelling their shareholder returns while a further 30 paid less than expected as the impact of the Covid pandemic took hold. It could get worse by the end of the year.

Underlying dividends are forecast to be 39% lower than were in 2019 at £60.5bn but could slide by as much as 43% to £56.3bn, according to Link, a financial administrator. Susan Ring, chief executive of corporate markets at Link, believes that 2020 will see the biggest hit to dividends for a generation.

“The gap between our best- and worst-case scenario is now just four percentage points, far narrower than our first estimate made in early April in the midst of the turmoil,” she added. Link goes further by claiming that the level of shareholder returns may not recover in 2021 and it could take six years before investors collect once again the cash return they enjoyed in 2019.

While it is understandable that companies are trying to maintain a strong balance sheet ahead of what is expected to be a deep downturn ahead, there are other theories as to why dividends were cut and may not make a speedy recovery.

Indeed, it has been reported by the FT that the chief executive of one asset manager has claimed some companies are using the global health crisis as an excuse to cut their dividend. Ring would not be surprised if such a re-set was the motivation for some.

“To some extent, companies in 2020 are also ensuring they don’t waste a good crisis. Dividend cover, a measure of affordability that relates pay-outs to profits, has been far lower in the UK than the global average. “2020 has provided an opportunity for many companies to reset their dividends at a lower, more sustainable level from which they can again start to rebuild.

In the short term this is painful for investors, but in the long run it helps create healthier companies. “This re-setting, together with the economic legacy of the pandemic, means it could take until 2026 for dividends to return to their 2019 level,” she added.

A global decline

This is not just an issue for UK equities. Research support’s Ring’s claim that dividend cover has been declining globally. This has been happening while shareholder payments have been rising. Indeed, the ratio between income and dividends was 2.9 times in 2010, which fell to 2.3 in 2018 and 2.1 last year.

A little more than two times covered by income is close to the level that some investors see dividends as being unsustainable. Whatever the reason, these are uncertain times and executives cannot be blamed for wanting to maintain strong cash reserves. Indeed, global profits could fall by a fifth to £1.7trn this year, Henderson International Income Trust says, adding that global dividends could fall by between 15% and 34%, which is more than they did during the credit crunch.

Oil major Shell is an example of how dire the situation is. In the second quarter its dividend was cut for the first time since the Second World War. This is a theme spread across the oil industry as investors collected £2.2bn less in dividends from such companies during the quarter, reflecting the collapse in oil prices, which fell to negative at one point. This crisis looks set to be worse than the credit crunch if a fall in dividends is an indicator.

Three quarters of UK equities that usually return cash to shareholders in the second quarter either didn’t or returned less than they did in the same period a year earlier. This compares to two-fifths of companies cutting or cancelling their dividend in the first quarter of 2009.

There may have been a recovery in some equity markets around the world, but companies will be trading in an uncertain world and while dividends have been rising faster than profits, perhaps this is a good time for a re-set to make shareholder returns more sustainable.

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