In­come pain

When div­i­dends must be cut

The Sunday Telegraph - Money & Business - - Money -

When Prov­i­dent Fi­nan­cial scrapped its div­i­dend in Au­gust fol­low­ing a ma­jor profit warn­ing – due to prob­lems stem­ming from its debt­col­lec­tion work­force – its shares plunged. They have not re­cov­ered. But a div­i­dend cut may some­times be a nec­es­sary part of the purge that puts an ail­ing busi­ness back on the road to suc­cess. Ad­di­tion­ally, a div­i­dend cut that sparks over-sell­ing can present a buy­ing op­por­tu­nity.

Many com­pa­nies cur­rently main­tain pay­outs that ap­pear un­sus­tain­able based on “div­i­dend cover” – a mea­sure of a com­pany’s abil­ity to sus­tain dis­tri­bu­tions out of prof­its. Div­i­dend cover of less than one in­di­cates prof­its do not cover the div­i­dend, and any­thing un­der 1.5 is typ­i­cally viewed as a con­cern.

Ac­cord­ing to screen­ing ser­vice Stock­o­pe­dia, of the 15 stocks in the FTSE 100 in­dex that have a div­i­dend yield of more than 5pc, 10 have a div­i­dend cover score of less than one.

Fac­ing up to re­al­ity

Min­ing stocks are one re­cent ex­am­ple where div­i­dend cuts be­came part of a life-sav­ing ne­ces­sity fol­low­ing the 2014-2015 com­mod­ity price col­lapse.

Juliet School­ing Lat­ter, of in­vest­ment shop Chelsea Fi­nan­cial Ser­vices, said: “Look at An­glo Amer­i­can. Af­ter sus­pend­ing its div­i­dend and an­nounc­ing in­vest­ment in a huge re­struc­tur­ing in 2015, the stock turned around. It is now over 200pc higher and pay­ing a div­i­dend again.”

She ex­plained that while a re­cov­ery in com­mod­ity prices played a part in An­glo Amer­i­can and other min­ers’ re­cov­ery, it was not the only fac­tor.

“By pay­ing down debt, in­stead of pay­ing big div­i­dends,they were able to re­pair their bal­ance sheets. Len­ders were less wor­ried they’d go bank­rupt, so they were able to re­fi­nance their debts more cheaply,” she said.

Stan­dard Char­tered, the bank, at­tracted sig­nif­i­cant in­vestor ire af­ter scrap­ping its div­i­dend in 2015. Ac­cord­ing to Chris Kin­der, man­ager of Columbia Thread­nee­dle’s UK fund, the div­i­dend was stopped in 2015 af­ter “rapid growth evap­o­rated in 2014”. A ma­jor re­struc­ture, in­clud­ing 15,000 job cuts, was un­der­taken, dur­ing which time the shares car­ried on fall­ing. The share price has since re­cov­ered some of the losses.

“They ap­pear to be pri­ori­tis­ing the long term, rather than fo­cus­ing on the share price boost from re­in­stat­ing the div­i­dend,” said Mr Kin­der.

One other busi­ness that has made a suc­cess of a div­i­dend cut re­cently has been Rolls-royce, ac­cord­ing to Mr Kin­der. “In Fe­bru­ary 2016, it cut its div­i­dend for the first time in 25 years. The share price rose over 30pc in days as in­vestors took en­cour­age­ment from the ab­sence of a profit warn­ing, af­ter five in two years.”

Now, a sig­nif­i­cant re­struc­ture has taken place, and the CEO is wait­ing pa­tiently to in­crease the div­i­dend. “Prob­lems re­main, but the stock is 70pc higher than its Fe­bru­ary 2016 low,” said Mr Kin­der.

Share­hold­ers’ thirst for in­come is part of the prob­lem

Fears of dis­pleas­ing in­vestors can some­times lead to firms pay­ing un­sus­tain­able div­i­dends by tak­ing on debt, sell­ing as­sets, or re­duc­ing in­vest­ment in fu­ture busi­ness.

“The big­gest risk is from a com­pany be­com­ing wed­ded to its div­i­dend and do­ing any­thing to sus­tain it,” said Eliz­a­beth Davis, one of the man­agers of Rath­bones’ £1.4bn In­come fund.

She pointed to con­struc­tion firm Car­il­lion, whose shares fell by more than 70pc in July af­ter it scrapped its div­i­dend. This was prompted by a dis­mal, un­ex­pected profit warn­ing, in which it an­nounced it was hav­ing to set aside £845m due to prob­lem con­tracts. On Fri­day, the firm fell sharply again, af­ter re­veal­ing a £1.2bn loss dur­ing the first half of the year.

“It was pay­ing a sub­stan­tial div­i­dend, but we saw debt ris­ing, mar­gins fall­ing and, when op­er­a­tional is­sues sur­faced, it didn’t have the cash re­serves needed to ride out the storm.”

Ms Davis flagged Next as an ex­am­ple of “man­age­ment con­tin­u­ing to re­turn cash to share­hold­ers when we would rather they didn’t”. She ex­plained that their div­i­dend de­ci­sions are made on “what is ob­vi­ous and mea­sur­able”, but that in­creas­ing in­vest­ment in IT in­stead could “fu­ture-proof ” the busi­ness against the likes of Ama­zon.

With in­ter­est rates so low, com­pa­nies can bor­row cheaply in order to pay div­i­dends.

“Com­pa­nies in the UK and US have taken on ever more debt to cover div­i­dends. This can’t con­tinue for­ever, and some com­pa­nies may strug­gle to re­fi­nance and be forced to cut div­i­dends,” said Ms School­ing Lat­ter.

‘The big­gest risk is a com­pany do­ing any­thing to sus­tain its div­i­dend pay­ment’

A model poses for Next, the re­tailer. An­a­lysts worry it is pay­ing out too much

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