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Coronavirus hits dividends – where to find income

We take a look at how coronavirus is impacting dividends and where investors could look for income.

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.

While international lockdowns are helping to control the spread of the virus, there’s no doubt it’s having an economic impact. Companies are generally selling less and actions by governments from around the world are continuing to affect global stock markets.

Lots of companies have seen their share price drop since mid-February, when the severity of the virus became clearer. But not all income-paying companies who have seen their share prices fall in the last six weeks will have to cut or cancel their dividend.

Please remember that yields go up and down in value and are not a reliable indicator of future income. This article isn’t personal advice. If you're not sure what’s right for your circumstances, please ask for advice.

Who's been hit the hardest?

If a company’s revenues are restricted, it means they have less cash to pay dividends. But some companies are more sensitive to the current market conditions than others.

This includes travel and leisure companies such as airlines, hotels, holiday resorts, cruise liners, cinemas and restaurants. It includes companies that sell goods and services that are deemed non-essential. The expectation is that a rise in unemployment, or a drop in household incomes, will mean people globally spend less on retail, particularly luxury goods.

Banks have been impacted too by the drop of the base rate by the Bank of England. This is because their ‘net interest margins’ will be squeezed – that’s the difference between what a bank pays depositors and charges borrowers. This in turn has also impacted lots of housebuilders because of certain mortgages being pulled from the market.

Car makers and industrial companies rely on the free movement of components such as parts or materials in their construction. Where borders are closed and sea tankers are grounded, this has impacted global supply chains meaning they can’t produce as much as they normally do.

Oil and mining stocks have also been greatly disrupted in recent weeks. The shutting down of industry in Asia and Europe has reduced demand. This coupled along with the failure in Saudi Arabia and Russia to reach an agreement on restricting supply led the oil price to fall to just $20 a barrel as at 30 March – this affects their ability to generate higher revenues as the product they sell is now worth less.

What should companies be doing?

Broadly, we can put dividend-paying stocks into three buckets.

In the first bucket are those companies who simply no longer have the cash to pay dividends. These cuts might be short-lived, and once freedom of movement is restored, and the public start spending again, they might return to the dividend table. But it’s currently too soon to predict when this might happen.

If a company can’t pay out a dividend, it’s right to cut now. It’s far better to focus on the long term health of a business, pay down debt, look after employees, and service clients. Paying out cash it doesn’t have could risk further problems down the line.

In the second bucket are companies which might have the cash to pay a dividend today, but it wouldn’t be sensible to do so. It might be that their industry regulator can see a better use for that cash, such as extending products and services to support the public, or ensuring staff levels are maintained. These companies might decide to cut their dividend now to protect the future of the business, and best serve employees and the public.

In the third bucket are firms which aren’t impacted by the change in consumer trends – the effect on their sales and general health of the business is limited. These companies have enough cash to continue to pay dividends through the current market conditions.

Which bucket a company falls into will depend on a number of things – like its sales, cash flows after production costs and debt levels. What is right for each company, and their shareholders, is best determined on a stock by stock basis.

Where could investors look for income?

We’ve spoken to a number of experienced UK equity income fund managers who traded through the 2008 global financial crisis. They’re estimating short-term dividend cuts of up to 30% for their funds over the coming months.

Following the fall in values since the beginning of the year, this reduces yields from around 7-8% on most UK equity income funds, to 5-6.5%. The yield is the income paid to investors relative to the current value of the investment.

While income on equities is expected to drop, a good UK equity income fund still provides a diversified stream of income – above the current rate of inflation. By this we mean the income being paid is generally greater than how quickly prices are rising.

But that can’t necessarily be said for bonds and, and certainly isn’t true for the majority of cash products.

We think there are very few alternatives for income investors to get better income returns than what equity income is offering, without taking on more risk.

Although no one really knows how long the impact of the virus is going to last, we take encouragement in the conversations we’ve had with a number of fund managers. Even if the expectations of large dividend cuts happen, a number of the firms are expected to reinstate dividends in the near to medium term although this is not guaranteed.

Selling out of equities now would potentially create a loss, and mean investors have fewer units to generate an income in the future. It’s not easy, but for those that can take a longer-term view, the best thing to do could be to hold tight.

This article isn’t personal advice. If you're not sure what’s right for your circumstances, please ask for advice.

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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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