Dividends and the pandemic: where are we eight months on?

Covid-19’s widespread financial damage includes an unparalleled hit to company dividends, meaning more tough times for income investors.

But the situation varies across sectors; it’s not all bad news. Charles Luke, Investment Manager of Murray Income Trust PLC, shares the latest on dividends – including signs of stability and renewed activity.

On 10 March, John Menzies was the first company to suspend its dividend due to the coronavirus. A raft of others followed. In the UK, 47 of the FTSE 100’s companies reduced, suspended or cancelled their dividends. And at least 100 of the FTSE 250’s companies did the same. Never before have we seen such widespread action at once.

It’s an obvious concern to investors. Dividends and dividend growth play a critical role in achieving sustainable income and long-term returns. Many studies show that the greatest proportion of total returns come from dividends and their reinvestment. But while the overall statistics on dividend cuts and delays are unprecedented, it’s not all bleak. Many companies have been able to stick to their dividend strategy despite the coronavirus crisis. And quality, sustainable income is out there, if you know where to look.

Companies acted for various reasons

There were several reasons behind the decision to cut or delay dividends. For some companies the decision was forced, for others it was financially critical, while it was a welcome relief in a few cases. For many companies, it was purely cautionary – to preserve cash in the incredibly uncertain economic climate.

The Bank of England’s Prudential Regulatory Authority told banks not to pay dividends. Meanwhile, those companies that used the government’s financial assistance packages could not justifiably follow this with dividend payouts to shareholders.

On the flipside, some companies such as Imperial Brands and Shell took advantage of the opportunity to lower dividends. This was especially the case if they had been over-distributing, had too much debt, or needed the cash for other investment needs.

So a very varied picture across sectors. Let’s take a deeper dive into the dividends situation.

A mixed bag

In real estate, how different subsectors performed very much depended on the purpose of the property. Lockdown resulted in the closure of many physical retail units so this area saw deep cuts to dividends. However, some companies were able to support or even increase their dividends. For instance, companies with self-storage or urban logistics assets, such as Safestore or LondonMetric, benefited from resilient demand and the growth of online retailers.

Hardest hit

It’s no surprise that the travel and leisure sector was one of the worst hit areas during lockdown. No revenue versus high fixed costs meant there were extensive dividend cuts across the sector, including companies such as Carnival and Whitbread.

Oil and gas, which had been over-distributing dividends previously, also made widespread cuts. But several headwinds are buffeting the sector. Lockdowns resulted in an unprecedented fall in global demand for oil, which led to oversupply and nowhere to store it. This meant owners of certain types of oil had to pay to find a home for it, which led to the most unusual situation of negative oil prices. Add to that the transition to renewable energy, and the sector had no choice but to act on dividends.

Elsewhere, the UK’s largest banks, including HSBC, Lloyds, Barclays and Royal Bank of Scotland, all slammed the breaks on dividends. As mentioned earlier, regulatory pressure was key but these companies face a challenging environment of low interest rates and likely increased loan impairments.

Able to maintain

It wasn’t all cuts or delays though. Some companies maintained their dividend payouts, supported by strong demand, robust balance sheets, flexible cost bases and recurring or needs-driven revenues.

A strong iron ore price supported mining companies. Rio Tinto, among others, was able to pay out. The majority of healthcare and pharmaceutical companies also maintained payments. This included AstraZeneca, GSK and Smith & Nephew.

And it was, relatively speaking, business as usual for some sectors. This included telecoms, utilities and food producers. Vodafone, National Grid, SSE and Unilever all dished out their dividends. Beverage giants Diageo and Coca-Cola Hellenic (see below) did the same. They were helped by strong off-trade business (the sale of drinks in supermarkets for example, to be consumed at home) partly offsetting weakness in ontrade (e.g. drinks sold in hotels and restaurants).

Where are we now?

While the fog of Covid-19 is clearing in some areas, enormous economic uncertainty remains. Many management teams are waiting on signs of the virus and economic activity stabilising further, and to understand the impact as furlough schemes end.

And many will prioritise repaying government support and additional borrowings over payments to shareholders. Even when they reinstate dividends, it may not be at the same level as previously. Priorities have changed for most companies.

But there are signs of encouragement. We’re seeing some company management becoming more confident about reinstating their dividends. Sometimes it’s a case that they were overly cautious at the height of the crisis. And it’s often the case that given their needs-driven characteristics, demand has remained robust – in the insurance sector for example.

Income investing can still work

There’s no doubt that income investing has had a difficult 12 months. First, there was the collapse of a high-profile fund and well-known investment manager turnover. Then Covid-19 – a hammer of human and financial distress – seemingly swung out of nowhere. It’s been a huge blow to dividends.

But this doesn’t point to the demise of income investing. It can still work – you just need to find the right companies to deliver sustainable income growth.

The search for sustainable income

At Murray Income Trust, we’ve always maintained a view that income investing should never be about chasing high yields. It should be about long-term sustainability and dividend growth.

It’s simple. To grow your dividends, you need to grow your earnings. And good quality companies can be better placed to do that. They’re also more likely to deliver on their dividend growth aspirations and pay special dividends.

A quality strategy is all the more important in these unprecedented times; low growth, low interest rates, high debt. Corporate profits will be under pressure for the foreseeable future. So it takes a careful, research-intensive approach to find the most resilient investments.

The right companies…
 
An income approach based on quality needs dependable companies with strong balance sheets. Those that can continue to grow their business, reinvest in it, partake in merger and acquisition activity, and grow their earnings year on year.

These quality businesses are more likely to be able to pay dividends, even when conditions change or are challenging. Of course dividends aren't always guaranteed, even if a company is growing year on year.

Similarly, we focus on companies with compelling long-term structural growth stories, perhaps with global brands or valuable intellectual property. In the current environment, some of the strongest companies should be able to grow stronger.

Earnings growth in a low growth world is likely to be prized more highly than ever. So companies with sustainable competitive advantages and pricing power will benefit disproportionately.

…in a diversified mix
 
The pandemic has affected different sectors in different ways – everything from severe loss to sudden growth.

Diversification, as always, is crucial. This can be achieved using different sectors but also a range of mid and large-cap stocks. It’s about ensuring that investment is not overly dependent on any one sector, trend or economic scenario.

Fundamentals and patience
 
The more you know the better, as in-depth knowledge can help to manage investment risk. It’s important to understand a company’s business model, how it manages its environmental, social and governance (ESG) factors, its competitive advantages and management team.

But gaining a clear picture of a company and what may change means combining several thorough approaches. Experienced analysts and ESG experts doing proprietary research and meeting face-to-face with company management – while also carefully considering the views of independent experts. The more you know, the more likely you are to see potential improvements and work with companies to achieve them.

As always, a long-term view is important. Human nature is to react to short-term panic, perhaps to chase lower-quality companies with the chimera of higher dividend yields. At Murray Income Trust, we believe that this rarely works. We seek quality companies that can stay the distance – those that will give us access to the many potential advantages of income investing for our clients.

The potential advantages of a quality income approach:

• dividends can be a key driver of total returns over time
• in a world of low numbers, UK dividends can be attractive versus other equity markets and asset classes
• companies with strong business models and robust balance sheets may benefit disproportionately
• more sustainable returns with a lower risk profile – high-quality companies are more likely to deliver their dividend aspirations and provide special dividends
• diversified income streams that are less cyclically exposed and compare favourably versus the concentrated dividend profile of the broader market
• potential for additional income via options that support income resilience, an independent income stream and an attractive yield.
   

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Important information

Risk factors you should consider prior to investing:

• The value of investments and the income from them can fall and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

Investors should review the relevant Key Information Document (KID) and brochure prior to making an investment decision. These can be obtained free of charge from www.invtrusts.co.uk or by writing to Aberdeen Fund Managers Limited, PO Box 9029, Chelmsford, CM99 2WJ.

FTSE International Limited (‘FTSE’) © FTSE 2019. ‘FTSE®’ is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. RAFI® is a registered trademark of Research Affiliates, LLC. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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