Dealing with reduced dividends
In previous downturns, dividend cuts have received a resounding thumbs-down from shareholders. The question is: are investors more amenable to seeing their sacred dividend payments slashed this time around?
The simple answer is that they seem to be split on the issue. On the one hand, many recognize that capital preservation in the current environment is of stark importance. On the other hand, those same investors are desperately crying out for some form of income. This is especially true for private investors, many of whom rely on regular dividend payments as a source of income during times when savings yield minimal interest. Either way, if data from Standard & Poor’s is anything to go by, 2009 looks like it will go down as one of the worst years for dividends in more than seven decades.
‘I think investors are just resigned to the fact that they have no choice but to forgo their dividends right now,’ says Justin Urquhart Stewart, founder of Seven Investment Management in the UK. He argues that investors’ attitudes have changed out of basic necessity. ‘A year ago, people would have been distraught if they’d heard BP’s dividend was being held at the same level,’ he says. ‘Now they are saying, Thank God!’
Points for payouts
That said, firms that are paying out are being handsomely rewarded in terms of positive investor sentiment. Defensive stocks such as pharmaceuticals, utilities and telecoms have featured among the more generous categories of dividend payer, much to the delight of cash-strapped investors.
Dutch telecoms firm KPN has recently coughed up, as have Royal Dutch Shell and pharmaceuticals company Novartis, which increased its payout by 25 percent. Indeed, Novartis’ handsome dividend may have been linked to a victory at its 2009 shareholder meeting: investors threw their weight behind the board, rejecting a proposal from minority shareholders to implement an annual consultative vote on the remuneration report.
‘Companies that can continue paying or even raise dividends in the downturn are sending one of the highest-quality signals you can to the market – it suggests a disciplined management team that is better prepared to weather the storm,’ points out Sonja Schemmann, global equities fund manager at Schroders.
She argues that investors often don’t punish firms’ share price when a cut is announced as the market has normally already anticipated restrictions on capital. ‘Generally the stock market responds to weaknesses before the dividend, which is why the share price sometimes rises,’ she explains. ‘In effect, it’s the market breathing a sigh of relief.’
This wasn’t the case for UK insurer Legal & General: its surprise announcement that it was halving its payouts led to a 10 percent drop in its share price. General Electric suffered similarly, its stock falling 8.1 percent after GE announced it was cutting its quarterly payout from 31 cents to 10 cents a share.
The reduction was cautiously welcomed by some quarters of the investment community who considered it long overdue. But GE’s reputation still suffered in part because it had previously insisted no dividend cut was necessary. ‘GE’s prior assurances about the dividend were unrealistic in light of market conditions, and we had argued that maintaining such a high dividend was unsound,’ Citi concluded in a research note issued after the announcement.
Income versus dilution
It may be tempting to keep paying out in an attempt to keep up the facade that all is well, but investors will not thank you for it in the long term. Urquhart Stewart argues that dividend cuts may be unwelcome but are still generally preferred to an equity capital raising. ‘When it comes to the decision, Do we forgo dividend or suffer a capital raising?, most investors would rather sacrifice the dividend than have their allocation diluted and have to invest more into the company,’ he says.
The key issue for investors now is evidence of security and stability. They are looking for prudence, and this is something they reasonably expect to apply to their dividends. ‘We look for long-term capital discipline and stability of underlying earnings – the dividend formula should be based on long-term growth,’ Schemmann explains. ‘In particular, the dividend for cyclical stocks should not have payout ratios beyond 20 percent to 30 percent.’
She hopes more firms will reassess their dividend policies in the long term. ‘I want to see better dividend programs alongside the underlying cyclical nature of the earnings stream,’ she says. ‘Companies in future can talk about how they can better align dividends with capital inflows.’
Investors would rather see an admission a dividend cut is on the cards sooner than later. Where painful cuts are made, they will want assurances that income will be more consistent in the future.