The dilemmas of dividends

Investing in dividendpaying stocks is often punted as a way to ensure a reliable stream of income regardless of what the markets do. But this simple investment truth is yet another thing the global Covid-19 pandemic has turned on its head, to the exasperation of investors who supplement their pensions with dividends, writes Lisa Steyn.

Investing in dividend-paying stocks is often punted as a way to ensure a reliable stream of income regardless of what the markets do. But in the wake of Covid-19 this simple investment truth is yet another thing the global pandemic has turned on its head.

Though stock markets have bounced back quicker than expected, jittery companies are still slashing and suspending dividends, even in some instances when they have been profitable.

It is a source of exasperation for investors such as 73-yearold Mohammed Gani*, who supplements his pension with dividend income from investments.

When he retired from the public service eight years ago, Gani opted to invest his gratuity — a one-off cash lump sum — in income-yielding investments, a portion of which went into preference shares, which are more partial to being awarded dividends even when ordinary shares are not.

He has had a near 30% capital loss on these investments over time. That is not Gani’s concern — he is only interested in the dividend income, which he now knows will drop off this year.

Samantha Hartard, portfolio manager at NinetyOne, says one does not have to wait until the reporting season has ended to see that dividends have been cut almost across the board. “It started happening for December year ends, March year ends and now more recently in June as well,” Hartard says.

It is not just in SA, she points out. In developed markets, in which interest rates have been persistently low, even negative, many income funds have been launched in recent years in the search for yield. They are now in a quandary as dividends are slashed abroad too.

The Janus Henderson Global Dividend index shows that the decline in global dividend payouts has been the largest since the index was started in 2009. The gauge dropped 22%, or $108bn, to $382bn in the second quarter of the year.

Wayne McCurrie of FNB Wealth says this is the first time in living memory that SA has experienced such a dramatic fall in banking and listed property dividends, two sectors that traditionally have been relied on for such disbursements.

Real estate investment trust (Reit) stocks are mandated to disburse at least 75% of their distributable earnings to shareholders, but the Financial Sector Conduct Authority agreed to allow Reits with year ends from February to September to postpone dividend payments.

The Reserve Bank directed banks, though still profitable, in April not to pay dividends, as it was concerned that Covid-19 could put added stress on the banking system.

If the directive is lifted, McCurrie expects banks to declare a dividend for the reporting period ending in December, “but for the whole year, dividends will probably still be down 75% from last year”.

Like retailers, SA consumer shares will still pay dividends, though perhaps somewhat smaller than in 2019, he says.

Gani says it is unjustified for companies to sit on cash rather than pay out dividends.

“Covid has become a handy excuse to hang everything on”, he says. “It has become a very convenient excuse to hold on to cash, to the detriment of shareholders.”

Hartard, however, thinks it is sensible. “In SA, the outlook in February, March, April was uncertain as to how this was going to play out. There was a need for these companies to review balance sheet strength and ensure they would be in a strong operating position as this pandemic passes,” she says.

Worse would be to declare a dividend only to backtrack six months later, having misread the environment and then needing to raise capital.

“It would not easily be forgiven by the market,” she says. Management teams would come under huge scrutiny.”

Still, it is no small thing to withhold dividends.

Peter Major, director of mining at Mergence Corporate Solutions, says dividends always matter to a good fund manager and investor as a safe, proven way of locking in a return. With a steady return from dividends, one has much less worry about management going haywire.

Warren Buffett doesn’t pay dividends, and for many years Bill Gates and Apple never paid dividends. But it didn’t matter because they have superb management and shareholders make their money on the capital gain,” he says.

“But they are the top 5%, of companies. For 95% or so company management, they are too often the idiots Buffett always warns us against.”

Over time, increasing returns come through the dividend and if, simultaneously, the management does something disastrous

— such as Sasol’s Lake Charles blunder in Louisiana, US — shareholders do not lose as much, having retained some or most of those earnings themselves over the years. As such companies that do not pay dividends are riskier than those that do, Major says.

It is becoming harder to find companies that have a good dividend policy nowadays, he says. That is Gani’s experience too.

“Dividends seem to have dried up on the JSE. On the preference shares there is very little liquidity ... There are quite a few that are big dividend payers, but you can’t lay your hands on that stock at any price because it’s so tightly held,” he says.

Hartard says identifying the dividend plays” is no longer as easy as going through a list and finding the big dividend-paying stocks. In the Covid-19 era especially, those yields are by no means guaranteed.

Some of the internationalised stocks, such as British American Tobacco or Naspers have remained stable or even benefited from the crisis and their dividends may be slightly higher than the norm.

Mining shares have proved to be the real outliers. With commodity prices surging and a rand that is weak, even precious metals producers are declaring fat dividends.

But as SA mining stocks are nowhere near being regular, investors are worried that the recent spate of disbursements is not very likely to be repeated in the medium and long term, says Major.

Historically, people “bought SA mining shares, especially the gold shares, for the dividend. Capital gain was a bonus.” But since the 1990s SA mining dividend yields have slipped hugely. Among the exceptions, Kumba has been consistent in paying good dividend yields — sometimes in the double digits.

Hartard say miners are not a dividend play. “It ’ s boom and bust with mining companies. The last thing you do, especially in the precious metals world, is ever build an investment case on them paying out a dividend.”

Still, for the moment dividends from the resources shares provide a saving grace for the likes of Gani. McCurrie says that because international companies and mining companies account for about 70% of the all share index, dividends for the index might ultimately only be down 10%-15% this year.

In the increasingly difficult search for yield, a few shares that remain unlikely to disappoint, Hartard says.

“Take British American Tobacco, or Vodacom, they are typically defensive companies [sales and earnings remain relatively stable during both economic upturns and downturns]. That is great when there is uncertainty in the world and high market volatility.”

For the rest, Hartard does not see a rush to resume dividends given the great uncertainty around economic recovery.

Wild-card mining shares aside, McCurrie expects dividends will only reach 2019’s levels again in two years.

Gani is hoping it will be sooner than that.

“They are going to run out of this [Covid-19] excuse. Most companies did it [withhold dividends] for interims, so by the time finals come up, it might be a reduced dividend, but they’ll have to cough up something to keep shareholders quiet.”

* Not his real name.

IDENTIFYING THE ‘ DIVIDEND PLAYS’ IS NO LONGER AS EASY AS GOING THROUGH A LIST. IN THE COVID19 ERA, YIELDS ARE NOT GUARANTEED