Yield Seeking Investors In For Tough Ride As Businesses Slash Dividends

Summary

• Globally, companies are deferring/cancelling dividend distributions, in addition to other cost-cutting measures, to maintain liquidity in a rapidly changing and uncertain economic environment.
• Investors who rely on dividend streams to make a living or build wealth may suffer a set back as dividends are expected to drop until 2021.
• Australian companies like Flight Centre Travel Group, Super Retail Group, Sydney Airport and Macquarie Group withdrew/slashed dividend payments until the virus subsides.
• Strong liquidity is highly imperative amidst lack of cash flow to keep businesses buoyant and maintain long-term shareholder value.

In the wake of crisis caused by the coronavirus pandemic, global financial markets moved into a panic mode. Several businesses around the world deferred or even cancelled dividend payments due to lack of earnings and business disruptions amidst stringent lockdown and social distancing measures being observed to contain the virus.

Businesses React to Supply Disruptions and Market Slowdown

Companies are providing a clear disclosure of the drastic measures being taken to sail through the pandemic to mitigate impact of a dividend cut on shareholders.

The unfathomable changes in the global economy and day-to-day business operations have prompted companies in Australia as well as Europe and the US, particularly in the adversely affected sectors like airlines, tourism and hospitality, to withdraw their earnings guidance and slash dividends while formulating a suitable line of defense.

Dividends are cash distributions paid out to shareholders by a business from after-tax earnings. Companies pay dividends as a fraction of their profits for a certain period to reward stakeholders as well as to encourage them to keep investing in the business. A promising dividend stock can be identified from its fiscal strength, nature of dividend payments (rising or falling) over a long period of time, comparable P/E ratio, whether it is operating in a strong sector, predictable and sustainable cashflow as well as confidence of company insiders in the stock.

In hindsight, after the 2008-09 global financial crisis, many companies declared temporary dividend cuts to preserve cash to address high uncertainty and economic slowdown.

Also, Read: 10 financial stocks for financial crisis - CGF, BEN, JHG, PNI, PTM, PDL, IFL, HUB, AMP, MPL

It is a déjà vu moment for the world as various market experts are fearing a recessionary scenario which usually stems from abrupt declines in spending given the extraordinary circumstances. Different governments across the world including Australia, United States, India, and the UK have released huge liquidity injections to support businesses, households and keep the economy buoyant.

Contracting Dividends Worldwide

In Australia, more and more companies have been slashing/deferring dividends in the wake of market uncertainty arising from COVID-19, a major health and economic crisis.

The Flight Centre Travel Group Limited (ASX:FLT), in March 2020, announced cancellation of its 2020 fiscal year interim dividend of 40 cps, which amounts to a total of $40.1 million, as management indicated that dividend was cut to preserve cash and protect long-term shareholder value due to the current uncertainty caused by COVID-19.

Subsequently, Super Retail Group Limited (ASX:SUL) cancelled its interim dividend for FY2020 of 21.5 cents per share, resulting in retained cash of $43 million in the business. Sydney Airport (ASX:SYD) also declared that it would not pay its half year dividend apart from implementing other measures like reducing CEO’s fixed remuneration and directors’ fees by 20 percent until June 2020.

Even financial services blue-chip giant Macquarie Group Limited (ASX:MQG) recently warned of challenging market conditions, as the Company’s FY20 profits tumbled by 8% and the Group slashed its full-year dividend to $4.30 per share, 25% down on the prior year.

Good Read: A Deep Contraction or Recession - RBA's take on Australian Economy

In early April 2020, the Australian Prudential Regulation Authority (APRA) recommended that dividends should be "materially" reduced for protecting capital and providing major lenders with the capacity to support the economy. At the same time, APRA suggested that suitable limit should be maintained by the Boards on executive cash bonuses.

In Europe too, the French government has requested companies to cancel dividends and the European Central Bank called out on Eurozone region banks to postpone dividends for as long as the COVID-19 pandemic lasts. In Norway, the national banking regulator pleaded the finance ministry to intervene and encourage companies to prioritise liquidity over dividends.

Impacts of Dividends Drying Up

While dividend cuts may impact cash inflows of investors holding shares in these companies, they would largely help the businesses in maintaining liquidity in such unprecedented times. During these difficult times, having a good liquidity is essential to keep the business in strong standing. At the same time, it is equally important for companies seeking funds to have a good credit rating as the lenders/banks feel hesitant to give money to risky customers.

On the flip side, a dividend cut sometimes negatively impact the stock price as market reacts negatively to a company's dividend cut announcement because investors and analysts fear the worst-case scenario.

Investors like retirees or risk averse individuals, who rely on the stream of dividend payments as a way to make a living as well as build long-term wealth, may be in for some temporary financial hardship and should be prepared for a meaningful drop in dividends, at least for the short term until 2021.

While the most impulsive investors would tend to sell shares of the companies, it is particularly imperative to keep a long-term horizon in mind as history suggests that markets and corporate profits eventually recover.

Have You Read: Investing During Crisis: Tips to Ride Through the Volatile Territory

Importance of Liquidity and Efficient Capital Allocation for Sustaining Crisis

Around the world, companies prepare to deal with the worst amidst a rapidly changing environment and formulating plans to control costs wherever possible, thus maintaining liquidity over short term.

Given the current global economic and geo-political disturbances, it is the most adequate move as the problem of liquidity eventually goes onto cause the issue of insolvency. And, economists from different countries are predicting that companies that do not have access to loans or are unable to issue debt are likely to have a challenge of insolvency coming their way.

Thus, it is imperative that small as well as large firms, particularly publicly traded corporations, implement stringent measures and manage their capital allocation, which is one of the most important responsibilities of a company’s management.

In the medium to long term, an efficient capital allocation, which is basically distributing an organisation’s financial resources, serves the benefit of shareholders too. At this point of major slump for economies around the world, management decisions to cut back costs and manage cash flows, will ultimately determine how quickly a company will rebound and how much money is returned to shareholders when things return to normal.

Must Read: Guide to Portfolio Strategies and Investment Avenues to Wade Through COVID-19 Crisis