How safe are dividends?

‘Thanks’ to the stock market crash, the FTSE 100 is yielding almost 6% today*. That’s almost 60 times the Bank of England base rate and considerably higher than returns on cash.

But is this yield sustainable?

The easiest option for companies in these unprecedented, uncertain times is to conserve cash, cut costs and cancel or suspend dividends. And that is what we are starting to see.

Just last week, the FTSE 100 yield was around 7%, so it has fallen already, with a number of companies including ITV and Next announcing cuts or saying dividend payments are under review.

FTSE 100 companies may be especially vulnerable since half the dividends come from just four sectors: oil & gas; banks; commodities and insurance - all of which must be challenging right now.

So, it seems likely that a decade of dividend increases is coming to an end, and equity income funds could also see their dividend pay-outs reduce.

We asked some equity income managers how they are weathering the dividend storm:

“During the second half of March we have seen many FTSE 350 companies either say they are not going to pay a dividend or rescind one that had been declared but not yet paid, commented Martin Cholwill, manager of Royal London UK Equity Income fund.

“I think we will see a lot more of that in the coming weeks - no company intending to access government support can justifiably pay out dividends to shareholders.

“So, the headline yield on the market is not to be believed - although there is an argument that these dividend cuts could be temporary short-term moves, if coronavirus gets under control quickly.

“The fund’s approach to investing in companies with sustainable dividends and sound finances will inevitably be seriously challenged by these exceptional circumstances, but I still believe that the fund should fare better than average, when we look back over this period when the coronavirus has blown over. I am focused on whether my investments have sufficient liquidity and solvency to see them through this period and I believe that they all do at this stage. Indeed, competitors businesses going bust could even help some of them longer term.”

What about the rest of the world?

According to Stuart Rhodes, manager of M&G Global Dividend, “Dividend cuts will be brutal this year.”

“Dividends are being tested, and we will find out which companies are robust enough to pay through thick and thin,” he said. “But I’m confident the vast majority of the fund will continue to grow – at the moment I think up to five holdings are at risk.

Companies in different countries, also tend to have different pay-out practices, as Jacob de Tusch-Lec, manager of Artemis Global Income, explains: “In Europe, dividend payments are ‘lumpy’, typically being paid just once a year – in April and May. Given the current lockdown, the annual general meetings at which these dividend pay-outs would have been rubber-stamped are now at risk.

“In the US, dividends are paid on a quarterly basis, so pay-outs are less at risk. If one quarter’s payment is missed due to the virus, then we would still have three more quarters to follow”.

Europe in focus

“There have been a number of cancellations and postponements announced in recent days, even by companies with very strong balance sheets, added George Cooke, manager of Montanaro European Income fund. “The situation is simply too uncertain at the moment, so companies are opting for prudence. They face political pressure as well.

“It may be that some of these are reinstated later in the year, but it is too early to say at this stage unfortunately. Thankfully our fund is underweight commodities, banks, airlines, hotels and direct retail, which may shield us somewhat on a relative basis, but the situation is certainly difficult for dividends at the moment and we won’t be completely immune from that.”

Andreas Zoellinger, manager of BlackRock Continental European Income fund added: “In terms of our portfolio holdings, Volvo has decided to cancel the intended payment of a special dividend, which could still be paid at a later stage, and Taylor Wimpey has suspended payment of a regular dividend.

“We have always been clear that dividend growth in any given year takes a backseat in an environment where protection of the value of assets and the integrity of the strategy is the most important thing. To that end, we will not endeavour to deliver dividend growth at all cost, and certainly not undertake portfolio changes against our fundamental conviction.

“Therefore, under the circumstances, and anticipating further dividend delays, it will be challenging to deliver dividend growth for 2020. However, given the fall in equity markets we should still be able to deliver an attractive dividend yield.”

Asia: first in, first out?

Richard Sennitt, manager of Schroder Asian Income fund, concluded: “An extended shutdown will inevitably lead to further dividend cuts. Earnings will come under pressure – they were forecast at about 10-11% this year in Asia but will likely contract now – and it will be difficult for companies to grow.

“But Asian companies do have robust balance sheets: the net gearing of Asian companies is far lower versus their global peers because, since the Asian financial crisis, Asian companies do not typically lever up. The oil price falls will also have a knock-on benefit for Asia because the continent is a net importer of oil.

“There has also been some normalisation in Asian countries as lockdown begins to be relaxed – on the ground we are seeing lots of people are now going back to work and some companies think they will be up to capacity by the end of this month. Restaurants are also opening up. This will have a positive effect on companies, but reinfection rates will need to be closely monitored.”

“Within the context of dividend cuts globally, Asia Pacific ex Japan has a lower pay-out ratio (45% vs 65% in UK) than peers and therefore has more of a buffer for an earnings fall.

“There is also a considerably higher number of companies making up the Asian market yield: 50% of the income in Asia comes from 50% of the stocks – so there is more wiggle room versus other regions, which are far more concentrated in that sense.”

*Source: Dividenddata, 27 March 2020

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The managers views are their own and do not constitute financial advice.