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What the coronavirus pandemic means for UK dividends

Nicholas Hyett, Equity Analyst, looks at recent dividend cuts, which companies are most vulnerable and what it means for investors in the long term.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

In recent weeks dozens of companies have announced that dividends and share buybacks will be scrapped, suspended or delayed.

It’s just one of the many human and financial consequences of the current coronavirus outbreak.

This article is not personal advice. All investments and their income can fall as well as rise in value so you could make a loss. Dividends are variable and not guaranteed. Seek advice if unsure.

Why are companies cutting their dividends?

The most striking theme to have emerged from the stock market during the current crisis is the near universal effort to “conserve cash”.

Cash is what’s used to pay salaries, service debt and fund expansion. In normal times it comes in two forms. Internally generated cash – the portion of profit which ends up as cash in the bank at the end of the year – and borrowing.

With sales collapsing as economies around the world move into lockdown, internal sources of cash have dried up. That’s left many companies reliant on borrowing to meet expenses. But, banks don’t offer customers unlimited cash, so it’s crucial companies keep the amount of cash they’re burning through to a minimum.

In 2019, UK listed companies paid out £110.5bn in dividends. That’s a cash cost that’s looking increasingly unsustainable.

Companies and sectors affected

Lots of the sectors directly impacted by the coronavirus outbreak were clearly unlikely to pay dividends this year – the likes of airlines, travel companies, pubs and restaurants.

But, we’re starting to see the knock on effects in other sectors too – especially with cyclical businesses whose success relies on a strong economy. Lots of the housebuilders have slashed their dividends as housing sales grind to a halt. Other cyclical businesses like advertising are feeling the squeeze too, as companies slash spending.

Banks, which accounted for 15% of FTSE 100 dividends last year, are worth a closer look.

The recent cut in the Bank of England interest rate from 0.75% to just 0.1% is bad news for banks. That’s because while the cut will likely be passed on to borrowers reasonably quickly, the rates that banks pay savers can’t be pushed much lower. That means net interest margins (the difference between what a bank earns on loans and pays on deposits) look set to be squeezed. That has a direct impact on how much profit they can make.

Significant increases in unemployment, and the possibility of a large number of bankruptcies could also dent profits, as bad loans rise.

In response, regulators have shifted capital requirements and provided access to cheap financing to keep banks lending to small businesses and individuals. It’s good for the economy and for banks in the long run. But at a time when the government and Bank of England are taking action to free up capital and support lending, paying surplus capital as a dividend is not a good look. We’ve now seen dividends being cut altogether in the short term.

It’s the same story for companies across the economy. Furloughing staff is one means of cutting cash costs, essentially putting staff on unpaid leave. In the UK, 80% of salary for furloughed staff is being paid by the government. We suspect that companies which aren’t paying large parts of their workforce will find it difficult to justify paying dividends.

Even companies like the supermarkets, which are dramatically increasing the number of people on the payroll, might feel it’s a politically poor time to be returning cash to investors.

What does this mean for dividends going forwards?

While dividends look set to be very low for the next 3-6 months, it’s possible to take a rosier view as you look further out.

Assuming lockdowns don’t drag on into the summer – and that’s quite a big assumption – then lots of companies could still be profitable this year. Some industries could even see pent up demand lead to a bumper second half.

We think it’s worth noting that several of the dividend announcements we’ve seen so far have been branded as delays or suspensions, rather than cancellations. It makes sense for management teams to be cautious in the current environment, with no-one knowing how long disruption will last. But if events turn out better than feared, we could see a better than usual round of final dividends, although of course there are no guarantees.

Investors should be aware though that the longer the lockdown lasts, the more debts will be built up. These could take years to pay down, and that will restrict the cash available to return to shareholders.

Unsatisfying though it is to hear, the outlook for UK dividends depends on one great unknown – how long the lockdown will last. But, if the UK is able to follow the Chinese lead and reduce restrictions after two or three months, then it would be a mistake to write-off dividends entirely.

In the meantime, we would urge particular caution when looking at dividend yields. Yields tend to look at payments in the past, so aren’t reflective of what you’ll get in the future as some companies change their dividend plans. Even if dividends do bounce back in the second half, it’s unlikely the market will pay out as much this year as last.

We’ve recently written a more detailed article on the dangers of historical ratios in the current environment which you might find useful. Ratios shouldn’t be looked at in isolation.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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