Rudi's View | Oct 31 2019
The story below was written on invitation by the Australian Shareholders' Association (ASA) and was published in this month's edition of ASA members magazine Equity.
Weekly Insights shall resume its normal format next week.
On Dividend Alert
By Rudi Filapek-Vandyck, Editor FNArena
I am still amazed, every single time, but with the year 2020 but a whisker away, there are still investors who use backward-looking data as the main support source for their investment strategy and portfolio. On my assessment, these investors are at risk of significant disappointment in the year ahead.
Firstly, before I explain what I see as one of the key sources for potential disappointment from here onwards, I'd like to recount a recent anecdote because it's not just inexperienced amateur investors who rely on (false) security from the past.
Two months ago I upset a rather well-known economist employed by a large financial institution for putting up a table online with implied dividend yields that were significantly different from what my forward-looking indicators were suggesting as the most plausible outcome.
The explanation that followed was the information had simply been copied from data-provider Iress. What could possibly be wrong with that? Well, the numbers are from the prior financial year. To illustrate why this can be important, I referred to one of my observations from about half a dozen years ago.
At that time, one of the national newspapers published a double spread story on dividends in the share market, accompanied by a table with backward looking, highly attractive looking dividend yields. Twelve months later, only one company from that table had not cut its dividend.
Looking back at past dividend statistics for the Australian share market, that story must have been published after FY14, with the subsequent year delivering the first year post-GFC when total dividends paid out to shareholders went backwards in Australia. My advice to shareholders today is: pay attention, because all the signals are suggesting the current financial year will become the second year post-GFC when total dividends go backwards.
In practice this means companies are finding it increasingly difficult to pay out more than they did the previous year. Already, the August reporting season provided plenty of signals and indications about escalating pressures on shareholder rewards and returns. Only twelve months earlier total dividends paid out in Australia to shareholders grew by 14% from the year prior.
In August this year, the total dividend gain was still more than 4%, but exclude the specials and the extras from asset sales and the underlying payout was actually lower than in August 2018. No less than 23 members of the ASX200 either reduced or scrapped their dividend altogether during the August reporting season.
On my assessment, this number can potentially double by February next year, when companies including Caltex Australia ((CTX)), G8 Education ((GEM)), Spark Infrastructure ((SKI)), and OZ Minerals ((OZL)) are likely to pay out less than they have in the past. Miners and energy producers have been among the better dividend payers these past few years, but that's about to change. It would take an incredibly large amount of investor optimism to not anticipate that companies such as Alumina ltd ((AWC)), BHP Group ((BHP)), Fortescue Metals ((FMG)), Whitehaven Coal ((WHC)) and New Hope Corp ((NHC)) will no longer enjoy the steadily growing cash flows that have supported unusually large payouts in recent years past.
As per usual, the weakest and the most vulnerable are the first to succumb to the operational squeeze from a two-speed, if not three-speed domestic economy, on top of slowing international growth. The August reporting season had barely finished before profit warnings followed from Incitec Pivot ((IPL)), Sims Metal Management ((SGM)) and CYBG ((CYB)). Be prepared for dividend cuts from peers including AGL Energy ((AGL)), CSR ((CSR)), Graincorp ((GNC)), Inghams Group ((ING)), South32 ((S32)), and others.
Many of these companies do not feature as a Go-To destination for most income seeking investors, but Australian banks do and apart from CYBG, dividends from Bank of Queensland ((BOQ)), Westpac ((WBC)) and Bendigo and Adelaide Bank ((BEN)) are equally considered as being "under threat". Some answers shall be provided when a number of banks releases financial results in the coming weeks.
Even if some of the dividend cuts may not turn out to be overly dramatic, the real message for investors should be that companies do not wish to disappoint shareholders until they can no longer avoid it. There is potential for a whole lot more negative news the longer the operational squeeze remains "on".
This new trend change in dividend payments can potentially also provide investors with an important signal regarding the outlook for the broader Australian share market. According to research released by analysts at Citi earlier this year, it appears there is a close relationship between dividends paid out to shareholders and the underlying direction for equities.
Historically, suggests Citi's analysis, equity markets can temporarily get panicky and volatile, but as long as dividends keep on growing, the market will eventually find its footing and resume its uptrend, in line with growing dividends. But this also implies the outlook might not be as solid when dividends go backwards.
As stated earlier, the last time dividends went backwards in Australia was in 2015. Once banks and similar yield stocks peaked in May of that year, there was not much joy to be had from most parts of the share market until February the following year. Assuming that correlation hasn't changed since, it might be wise to not have overly optimistic expectations for the months ahead. Unless the underlying dynamics for corporate profits and cash flows changes dramatically, of course.
In the meantime, be aware that risks are rising. A review of the portfolio and its constituents might be appropriate.
FNArena offers self-managing investors proprietary tools and insights, including forward looking estimates. The service can be trialled for free at www.fnarena.com