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A bonfire of the dividends!

Dividends are a function of cash flow, and cash flows will undoubtedly come under intense pressure.  (Richard Bernstein- March 2020)

Two weeks ago I wrote* about Buying in Market Meltdowns. One of the features of that piece was looking at the eye-watering dividends that were available in the FTSE100. By way of recap they were (with estimated dividend cover for 2020 in brackets):

1.       Imperial Brands (IMB) (Tobacco)- 15.78% (1.22)
2.       Shell (RDSB) (Oil)- 13.49% (1.26)
3.       BP (BP.) (Oil) - 12.10% (1.22)
4.       BT (BT.) (Telecoms)- 10.22% (1.55)
5.       WPP (Advertising)- 10.78% (1.45)
6.       HSBC (HSBA) (Banking)- 9.14% (1.28)
(Source- Stockopedia- 13 March 2020).

Out of interest they now are as follows:

1.       Imperial Brands (IMB) (Tobacco)- 15.70% (1.25)
2.       Shell (RDSB) (Oil)- 12.1% (0.78)
3.       BP (BP.) (Oil) - 10.6% (0.68)
4.       BT (BT.) (Telecoms)- 12.7% (1.55)
5.       WPP (Advertising)- 11.6% (1.40)
6.       HSBC (HSBA) (Banking)- 8.67% (1.25)
(Source- Stockopedia- 28 March 2020).

Of course there is an inherent problem in relying on these figures in that most companies have now ceased providing forward guidance to the Market - at least until the extent of the CV19 effect is known. There are however a couple of interesting points to observe:

1. The two oil companies BP and RDSB (both of which saw big one day surges in share price this week) have both fallen into the “red zone” for dividend coverage. Put simply they will have to use their cash reserves or borrow money to maintain their present dividend. Royal Dutch Shell is proud of never having had to cuts its dividend for 75 years. I imagine that it is now coming under pressure, like never before.

2. BT has seen its share prices increase since 13th March, albeit dividends guidance seems to have improved with coverage maintained. We won’t know for sure until they next report to the Market on 7th May 2020, however with the current reliance of the UK’s housebound population on their core services they appear to moving into becoming a more defensive play.

What is striking about these six is that none of them have yet announced a dividend cut or suspension to the Market. That is quite unlike a lot of the rest of the Market.

I have spent some time today studying the list of dividend cuts. In short it adds out to an enormous amount of money- £4.3 billion of dividends went this week by my calculation. I thought it would be helpful to add a few of my own thoughts on these:

1. The vast majority are in cyclical as opposed to defensive style businesses. “Cyclical” tends to denote a business that sell products or services that do well in good times but will suffer disproportionately in a downturn. They include:

(a) Housebuilders (almost all have stopped work on sites)
(b) Manufacturers & building suppliers (they have no-one to sell to)
(c) Media companies (advertising is going to take a hit as discretionary spend plunges)
(d) Retailers (almost all with a physical presence have had to close)
(e) Leisure operators (ditto)
(f) Motor retailers (you can’t even drive to beauty spots to walk, so why buy a car to sit on your drive)
(g) Banks (profits will be under pressure due to all these payment holidays)
(h) Law Firms (transactions are going to drop in the near term)

Actually looking down the list, few would accuse these businesses of knee-jerk responses. Almost all of them are going to see their cash reserves come under pressure now in 2020. As a company, why would you pay out cash when you’re going to need it?

2. We are unlikely to see restoration of dividends until the landscape is better known. I am afraid that is unlikely to be as soon as June 2020. The more that investors realise this, the more downward pressure is likely to come on share prices. No longer is the investor being “paid to wait”. Instead he or she is speculating on growth in embattled times. Many may wish to sell out now and wait for recovery.

3. Cash is King in the pockets of investors (who will be able to pick up bargains at some point) and in the hands of companies who survive this downturn. One of the truths of capitalism is that recessions tend to remove weaker businesses, allowing the strongest to profit from the space that exists when the recovery comes. Companies with lots of cash on the balance sheet will almost certainly endure.

4. Defensive and/or well capitalised businesses are absent from the list. That leads me to the tentative conclusion that there should now be even more of a premium on share prices for these businesses as we move forward provided that:

(a) they are truly defensive- i.e. they sell products or provide services that will do well in a recession
(b) they have sound balance sheets going into this
(c) they have sufficient dividend coverage and
(d) they are responding actively to the challenges presently faced

5. Reinvested dividends has proven to one of the best long term strategies for the patient investor. With so many (predominantly) cyclical businesses now no longer paying dividends, there is nothing to reinvest. Unless the cut is short-term, it is going to damage long term returns. Timing exit and re-entry from these shares could prove to be a profitable strategy, albeit nothing is guaranteed.

Up to now, I have not had a part of my portfolio that has focused on dividend players. I would like to investigate this for the future albeit the work I’ve done on the above will perhaps alter my focus in the immediate term. Defensives perhaps may become flavour of the month….

*This blog is published subject to this disclaimer.


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