Dividend cuts and what they mean for income investors

The synchronised global shutdown, caused by the Coronavirus, presents an unprecedented challenge to dividends payments: more than a quarter of companies in the FTSE 350 have already suspended or cancelled dividends, and more announcements are expected to follow in the coming days and weeks. It’s the same picture in other countries, and this mass threat to dividends is naturally of great concern to investors relying on them for income.

A bit of good news

The first bit of good news is that some companies should be more resilient: those in the consumer staples, utilities and pharmaceuticals, for example. Some companies, like supermarkets, may actually benefit from lockdown.

Another piece of good news is that dividends won’t disappear completely – some companies may just suspend payments until later in the year, while others will reduce rather than cancel.

The final bit of good news is that most fund managers we have spoken to believe the cuts will be temporary and dividends will resume in 2021.

What UK equity income fund managers say

Carl Stick, manager of Rathbone Income fund, says: “We are not just seeing a global slowdown, we are seeing the operations of many industries grind to an absolute halt. We want to protect and grow capital and to give our unitholders a pay-rise every year, but we recognise that we cannot, Canute-like, restrain the tide. Many of our businesses will elect to defer dividends, because it is the prudent thing to do.

“On a positive note, we hope the strongest companies will return to previous levels of operation, and therefore earnings and dividend. We also own many businesses that are likely to continue paying out a proportion of their earnings to shareholders throughout this year.

“We intend to proceed with the fund’s interim distribution as planned; any challenge, if it arises, will come in the final distribution. A pay-out is very important, but so is running the fund as well as we can, and at this juncture pragmatism must prevail over dogma.”

Laura Foll, co-manager of Lowland Investment Company, says: “Companies are grappling with three ‘shocks’ at the moment: a supply-side shock; a demand-side shock; and an oil price shock. Earnings are falling rapidly, and we are looking carefully at the balance sheets and cash positions of our holdings, as well as how much headroom they have in their borrowing facilities.

“We are seeing a number of dividend cuts at the moment and I think this is the right thing to do. Of course, as an investment trust, Lowland is also able to fall back on its revenue reserves if necessary. We have a substantial reserve pot that we have not touched since the global financial crisis, so we are in a good position to be able to maintain the trust’s dividend pay-out and growth, even though the underlying dividend may have a difficult year.”

Job Curtis, manager of City of London investment trust, told us about previous times he has used the trust’s revenue reserve at our investment dinner last year:

Martin Cholwell, manager of Royal London UK Equity Income says: “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 coronavirus has blown over.

“I suspect most companies that have historically prioritised dividend payments will quickly return to paying regular dividends, albeit the quantum may be rebased in some cases. In a world that continues to be hungry for income, I believe that, once we have put coronavirus behind us, the UK stock market will still be an attractive and sustainable source of income and that well executed equity income strategies can again flourish.”

Ken Wotton, manager of LF Gresham House UK Multi-Cap Income fund, says: “We’ve spent the past few weeks calling round the companies our portfolio to better understand the demand and supply implications and financial position of each holding.

“We have then divested from those companies where we now have lower conviction and deployed the cash to holdings we are more positive about. We’ve also very selectively added new stocks: for example, Moneysupermarket, which is a market leader and is now available at a much more attractive price.

“We are anticipating a Q4 2020 recovery, but obviously the situation is very fluid. The fund has a bias towards smaller companies, which means the portfolio is sheltered somewhat from the big cuts we have seen in the dividends of the UK’s larger companies and whole sectors in some cases. However, the fund is not immune, and we expect some smaller companies to cut too. So we are assessing the imminent risks and whether they are short or long-term in nature.”

What overseas equity income managers are saying:

Andreas Zoellinger, manager of BlackRock Continental European Income, explained what is happening to European dividends in the Investing on the go podcast this week.

Ian Simmons, manager of Magna Emerging Markets Dividend says: “We have gone through the portfolio again and updated our expectations for dividends over the coming year. The headline is that our portfolio holdings in local currency are currently expected to see dividends down 2% on average. In an environment where earnings will be slashed, we see this as an encouraging result, especially considering share prices are down 20-50%, and across the board we expect normal service to be resumed as soon as the virus is alleviated, hopefully well before 2021.

“Some holdings will see more significant cuts than others, but we genuinely believe it to be temporary, and in many cases, they have the balance sheet to continue paying, but management are being very conservative. Some companies have already suggested that, assuming the virus passes, and life returns to normal, they will attempt to make up for any skipped interim dividends around the end of the year. Some of our holdings also have the ability to pay specials later this year.”

Richard Sennitt, manager of Schroder Asian Income says: “Ultimately, dividends are going to be driven by earnings, so the key is how long this slump lasts. Currently we are going through earnings season for Asia and it is perhaps surprising how few companies thus far are using the current crisis to cut dividends, perhaps driven by a motivation to funnel cash upwards in the case of state-owned enterprises and family-controlled entities.

“This is not to say that Asia is not immune to cuts and, if one looks at Australia and New Zealand, their pay-out ratios are high by regional standards and some areas of the markets valuations suggest dividend cuts are expected. The crunch point for dividends in Asia will likely come post interims in the summer, by which time there hopefully will be a bit more clarity as to the impact on growth and earnings from the virus.”