Jamie Clark

The distressed, the prudent and the mandated

Jamie Clark

Dividends remain a key talking point as UK companies struggle with the economic shock of coronavirus.

 

In the crisis to date, 165 FTSE All-Share companies have cancelled dividends. That’s more than a quarter of the its constituents, or 30% of all dividend payers. Proportionately, things seem worse in the FTSE 100 where 39% of companies have scrapped distributions. This is astonishing.

 

Equally shocking is the risk that there’s more to come. Whilst fiscal and monetary stimulus has been substantial, aggressive and immediate, it’s improbable that any recovery will be ‘v-shaped’. The revivifying effects of stimulus are felt with a lag, whilst the policy response has been assembled on the hoof and may be applied imperfectly. We may also be prone to subsequent disease peaks, which could demand renewed economic lockdowns. This says nothing of the damage already inflicted on the appetites of entrepreneurs and consumers.

 

Earnings and dividends therefore remain vulnerable. Judging by the December FTSE 100 Dividend Future, traders expect UK dividends to fall more than 45% from pre-Covid levels. For context, Russell’s FTSE 100 Declared Dividend Index, an expression of current year ex-dividend payments, is just 30% beneath the comparable period last year. Whilst the comparison is imperfect, the difference between the two measures tells us that markets think UK dividends will decline further.

 

As companies have updated investors on the impact of Covid-19, we’ve evolved a simple taxonomy of dividend cutters. This allows us to sort them into representative buckets according to the cause of each dividend cut. More importantly, it permits a judgment as to whether a dividend has been cancelled or deferred. Such information is key to deciding whether to add, hold or sell an investment.

 

Our taxonomy of dividend cuts has three categories:

  • The distressed: businesses where operational challenges, or indebtedness demand cash preservation;
  • The prudent: companies that have omitted dividends due to lack of visibility;
  • The mandated: cancellations resulting from political, or regulatory pressure.

 

As income managers, we know that leverage and misfiring business models are red flags when identifying dividend opportunities. Such businesses are the distressed. Typically, these were early dividend cutters, as the pinch of economic lockdown forced painful choices. Good examples include non-holds like Marks & Spencer, with its record of shrinking profits, and Micro Focus, the debt-laden software business. Such companies wouldn’t normally make great investments and the valuation shock of Covid-19 doesn’t make them bargains.

 

Assessing the prudent is trickier. Present circumstances lack for true precedent and March’s sell-off was record-breaking. Against this backdrop, it is rational for CEOs to favour cash preservation over shareholder returns. Parse the text of Covid-19 dividend cancellations and you’ll see that management are beset by uncertainty. Accordingly, this isn’t just an issue for conventional income stocks, but also for quality style businesses with seemingly well-covered payments (Compass Group, Next, Rentokil, Rightmove); something affirmed by the suspension of equally discretionary share buybacks (Sage, RELX, Diageo).

 

Should investors stick, or twist with the prudent? Our take on the Fund’s housebuilders may suggest an adaptable framework. Firstly, whilst the cessation of dividends is disappointing, we know Covid-19 has little bearing on the UK’s structural undersupply of housing and long-term demand. Secondly, where visibility is absent and forecast earnings are more useless than usual, we can look to a company’s earnings power, or typical through-the-cycle earnings. This can anchor current valuations and our expectations of future earnings and dividends. On this evidence, we are inclined to stick.

 

The mandated covers political cancellations. This includes banks, insurers and companies drawing state support. We own UK banks and are troubled by April’s mandatory cuts. Capital looks adequate and stress-testing has been stringent. Whilst dividends are now a prospect for 2021, retaining cash offers the consolation of buttressing solvency. We remain holders because absolute and sector-relative valuations are approaching 2008 lows, albeit without a financial crisis. RBS has been sold because this well capitalised bank is no longer a capital return prospect and majority state ownership makes it uniquely vulnerable to interference.

 

Things are less stark for insurers. Some have cancelled (Aviva, Direct Line), others have scrapped special dividends only (Admiral) and yet others intend to maintain payments (Legal & General, Phoenix, Prudential, Hastings, Sabre). This reflects the regulator’s more discretionary approach and suggests that where waived, insurers should reinstate dividends sooner than banks. We remain holders.

 

Whilst this taxonomy of dividend cuts isn’t exhaustive, it could prove a useful rule of thumb in filtering companies. Equally, we should remember that many dividend cuts have been made in the jaws of acute uncertainty. Although an immediate recovery is unlikely, it’s possible that some dividends are reinstated as visibility improves. Certainly, many cancellation statements are worded in this way. Timing this is impossible and discarding such businesses wholesale risks foregoing share price gains.

 

The pace of dividend cuts is slowing, however. Of the 165 cancellations to date, 92 were made in March and 73 in April. Just one week in March saw 59 cuts (week commencing 23rd). In the last week since 27th April, only five All-Share companies have cancelled or reduced dividends. More cuts are due, but this is an improvement.

 

While we wait, it is possible to cushion the blow of cancellations by adding companies with records of persistent dividends during macro crises. Notwithstanding Sainsbury’s deferral, supermarkets are an excellent example. We might also look for companies with acyclical earnings. As demonstrated by strong recent trading, spread better IG epitomises this quality.

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, May 6, 2020, 2:50 PM