UK dividends: weathering challenges, capturing opportunities.
In direct response to the COVID-19 pandemic, the current outlook for dividends paid by UK-listed companies looks rather gloomy. It is not inconceivable to think that dividends for the FTSE All-Share Index could fall by more than 40% in 2020.
An uncertain path out of lockdown
Government-mandated social distancing measures remain in place for a large proportion of countries across the world. While slowing the transmission of the virus, social distancing also reduces economic activity, putting extreme pressure on cashflows and liquidity for many corporates.
The path out of lockdown remains uncertain and is likely to change – and introduced through phases – as our understanding of coronavirus improves. The primary drivers will be an awareness of COVID-19’s prevalence in the general population, the ability of health services to deal with infection surges, improvements in medical treatments such as antiviral drugs, and the economic expediency of getting the economy back on its feet. Until we have a widespread high-sensitivity serological (blood) test, we cannot understand the extent of those affected by the virus.
Many UK-listed companies have put in place measures to conserve cash. Management teams have taken the difficult step of furloughing employees, funds have been drawn down from banks, all non-essential expenditure curtailed, and dividends cancelled across a range of sectors – this includes banks, insurers, travel & leisure, retailers, and building & construction.
Widespread dividend cuts
Of the dividends normally paid in the first half of the year, £20.8bn out of £44.9bn have been cancelled, representing 47% of all payments cancelled during this period1 – while a further £14.7bn in dividends are ‘pending’, having been announced but not yet paid.
Moreover, oil prices have plummeted following reduced demand from fewer cars on the road and a virtual absence of planes in the sky. In response, Royal Dutch Shell reduced its quarterly dividend by two-thirds – the company’s first dividend cut since the Second World War. Shell’s dividend payments amounted to £12bn in 2019, so a 66% cut will reduce UK dividends by £8bn, or 7% of all those paid by FTSE All-Share constituents.
Regulatory pressure over dividend payments amid COVID-19 crisis
A further factor may also come into play via political and regulatory pressure. The UK banking regulator, the Prudential Regulation Authority (PRA), wrote on 24 March to the seven largest systemically important UK deposit takers, asking them to cancel final dividends in respect of 2019 and all dividend payments for 2020. Dividends paid by UK-listed banks amounted to over £15bn in 20192 . So, the decision to cancel dividend payments by banks will have a huge bearing on the overall total.
These actions could also extend to other sectors, the most obvious being insurance. In early April, the PRA reminded insurance companies of their need to maintain good solvency while ensuring commitments to policyholders are met.
Comparing the GFC to COVID-19: From peak to trough
Taken in isolation, the cancellation of bank dividends for 2020 will amount to a 15% reduction in all UK dividends. However, when cuts in other sectors by companies, such as Royal Dutch Shell, are added in, the magnitude of the reduction is likely to dwarf the fall in dividends during the global financial crisis (GFC).
This crisis differs from the GFC in that its impacts are being more widely felt around the globe and the scale of the downturn is much greater. So, unlike the GFC when dividends recovered to pre-crisis levels in three years, we think it will take longer for them to return to the £110bn paid out by UK-listed companies in 2019.
We believe most management teams recognise the importance of dividends and their role in the compounding of returns. Company boards are keen to return to the dividend-paying list.
It is worth remembering that, despite the likely cuts, the dividend yield on the FTSE All-Share Index is highly likely to exceed inflation. At the end of March 2020, the FTSE All-Share Index had an historic yield of 5.4%. Even in a scenario where dividends fall 50%, the yield on the stock market still comfortably exceeds inflation. In a more central scenario where dividends fall 40%, the FTSE All-Share yield, based on the March 2020 level, remains over double that of inflation3 .
“Out of adversity comes opportunity” – Benjamin Franklin
We expect that the situation will become clearer as lockdown conditions are lifted. We will then have a better understanding of the true scale and nature of the economic devastation wreaked by the coronavirus.
Economic crises present challenges for consumers, companies and governments alike. Our experience is that the best management teams take these challenges in their stride. We have faith in the businesses and management teams in which we invest to capture opportunities where they occur.
Looking ahead, the economic environment will be different from conditions experienced prior to the virus. This may necessitate some changes to our strategy as business models are challenged by changed circumstances or we are offered the opportunity to invest in exceptional businesses at reasonable prices.
Finally, we have been really encouraged by the steps that employees and management teams have been taking to combat COVID-19. Whether it has been to protect employees (consciously putting employee health above profit), helping in the search for a vaccine, contributing personal protection equipment to keyworkers or donating to charities. The commitment to fighting the virus has been widespread and tremendous.
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