Dividend payments by Corporate Australia are very critical to some Australian retail investors as well as sophisticated investors who are running income strategies.
In investments, the returns are generated by the appreciation of invested capital or capital gains and cash payments to the holders that usually comes in the form of dividends.
The dividends paid by the companies primarily depends on the underlying earnings of the business. Board of the company takes the decisions on the dividend payments to the shareholders.
A range of factors could impact the dividend payments by a company. Apart from earnings of the business, dividend payments are impacted by the investment decisions, financing costs, contingent liabilities etc.
At the same time, businesses have to abide by the legal conditions that are followed prior to the dividend payments. Section 254T of the Corporation Act lays the principles of dividends payments for companies. Australian companies are required to pass the profit test and net assets test before announcing any dividends to the shareholders.
When volatility grips markets, like now, the investors come under the grip of fear and the share prices on the stock exchanges witness rapid/indiscriminate selling, and oversold situations. However, when volatility eases, the investors are likely to prefer companies with long term promising prospects that could deliver sustainable shareholder returns, including dividends.
And, this high conviction on promising businesses usually enables such businesses to bounce back must faster compared to the overall market recovery.
Australia’s dividend affection
Labor Party had intended to scrap franking dividend policy, which faced a widespread backlash from the Australian investors. Although the Labor Party did not come to power, it reflected the importance the franking credits in our country.
Put it simply, the dividend imputation laws were introduced in 1987 that removed the tax cascading on dividends at corporate as well as personal income levels. Dividend imputation laws have made sure that the income of Australian companies is only taxed at one level even when it is passed on to shareholders in the form of dividends.
Still, there are many countries around the world that tax corporate income initially under corporate tax provisions. Consequently, dividends are paid out of the already taxed income to the shareholders, which are further taxed when they file for income tax.
In 2016, Michelle Bergmann of the RBA penned an interesting paper on Australian dividends. It was discovered that despite modest earnings growth, dividends paid by the Australian companies had grown substantially since the Global Financial Crisis, especially the dividends paid by the large resources’ companies and the banks.
In 2015, Australian companies announced dividends worth $78 billion, reflecting a collective pay-out ratio of 81% against underlying earnings, and a 4.8% yield against the collective market capitalisation at the end of June 2015, as per the paper.
It was understood that since 2010, dividend pay-outs had increased in banks and resources companies, while other sectors were flat. The swings in the pay-out ratio of resource companies are due to the cyclical nature of the business. Major dividend paying companies include large banks, miners, supermarkets, and telecommunications businesses.
Firms were willing to increase dividends in dollar terms as earnings improved. Even when earnings are lower, some companies were maintaining a similar level of dollar payments, while most of the companies intended to lower dividend payments when losses were incurred.
She also noted that shareholder demand for dividends had induced a rise in dividends, and such investors are likely to prefer companies that pay cash dividends. Meanwhile, a lower interest rate regime might have fuelled the demand for dividend stocks, especially with franking credits.
It was also noted that high dividend paying equities had outperformed the broader Australian index since 2011 on a total return basis, and these businesses do command higher valuations.
RBA expects the recovery to begin in September
On Tuesday, the RBA Governor, Philip Lowe made a public appearance. He basically emphasised on the current outlook of the economy and the nature and speed of recovery.
Mr Lowe spoke about the halt induced by the measures undertaken to prevent the spread of the COVID-19, which is hurting income and job at present, while it may alter the spending and investments decisions of households & businesses in the future.
RBA expects national output to contract by 10% in the first half, total hours worked to fall by 20% and unemployment to reach 10% by June. Inflation is expected to be lower in the June quarter with an expectation of a negative number.
He noted that once virus spread is contained, the floor for economic recovery is in place, and the intensity of the recovery is dependent on the length of a halt in economic activities.
Assuming that most of the restrictions are removed by late this year, except international travel; the RBA expects the economy to begin recovering from September quarter, which would make the base for strong economic growth next year.
The banks also suspect mindset changes in businesses as well as households, and precautionary behaviour is likely to be here for a while. Also, some businesses may not reopen, household debts pose risks, and there could be structural changes in the economy.
When Mr Lowe was asked on the banking dividends, he noted that dividends are likely to be lower, but given the high levels of capital held by the banks – major banks could pay dividends.
It was said that the Australians rely on the dividend income. APRA has told banks to consider extensive stress testing prior to announcing any dividends. He noted that banks have been striking balance in capital and dividend payments and do not expect a ban on dividends.
Companies deferred or cancelled dividend payments already
Since cash flows of many businesses have witnessed a sudden stop, it is making the survival of ill-managed businesses harder, and the unknown timing of return to normalcy has been triggering uncertainty.
Ever since virus infection intensified domestically, the businesses have been looking to preserve cash and raise capital in an effort to survive at the backdrop of this economic meltdown.
As virus jitters intensified when Corporate Australia completed the earnings seasons with fresh dividend announcements, now the dividend announcements are either deferred or cancelled by the companies.
Many businesses have been issuing a large number of shares to raise capital, which will dilute the shareholder stakes and lower the future dividend payments when one is not buying during the fresh capital raising.
Essential services businesses who have been operating amid this economic meltdown are likely to be the ones delivering earnings growth, thereby dividends. Over the past month, there has been a significant flight towards such businesses.
Street analysts are predicting that around 40% of the listed Australian companies could lower or defer the dividend payments in the wake of COVID-19 crisis. Some say that top 200 bracket could see dividend cuts of around over 26%, which was seen during the Global Financial Crisis.
Although policymakers have not taken hard steps like banning dividends, a large part of Australia Inc mainstream players have either deferred or lowered the dividends already.