The reduction or complete removal of dividend payments has characterised the earnings season for the first half of 2020. As the COVID-19 pandemic continues to disrupt global economies, heightened concern over future earnings expectations led companies to reduce capital expenditures which were not deemed critical, and announce the removal or reduction of share buybacks and dividend payments in order to prioritise liquidity and preserve cash.
Communication on dividend pay-outs conveys information to the investment community. Companies which historically hold a strong track record of dividend payments usually are in a position of financial strength. Stable dividend players tend to enjoy a dominant position in their industry, have a global exposure with high return on assets and have low debt ratios on their balance sheet. Most importantly, earnings across stable dividend payers are less volatile over the years.
The key information to the investor, however, lies within the change in dividend payment decisions rather than the level of pay-out. Given that companies tend to choose a dividend pay-out level that is sustainable over a number of years, a company’s decision to increase its dividend carries a powerful positive signal about its long-run sustainable level of earnings. Conversely, when a company communicates a reduction or omission in dividend, that message is inherently negative, communicating concerns about future earnings and consequently shareholder returns.
The two primary drivers underpinning the current dividend cuts are the increase in volatility of future expected earnings and the importance of maintaining financial flexibility. The expected profitability and the speed at which earnings will recover is currently under the spot-light, as markets continuously assess the long-term implications of this economic downturn. Moreover, the majority of companies have taken a cautious approach and opted to hold on to cash and to ensure that credit lines are in place, in order to buffer against unforeseen operating needs to weather this downturn.
In comparison to the first half of 2019, aggregate gross dividend payments per share for companies listed on the Euro Stoxx 600, have declined by one third during 2020. The downward revision in dividend payments, however, was not reflected equally across all sectors. European banks, for instance, are currently forced by regulators not to pay out dividend payments to shareholders in order to retain capital on their balance sheets. Consumer discretionary stocks, such as auto companies, recorded among the largest decline in dividends during the first half of the year as the companies reported weaker bottom lines. Naturally, the more defensive sectors, mainly health care and consumer goods have managed to maintain approximately the same levels of dividend payment of the first half of 2019.
Despite the aggregate decline in dividend pay-outs during the pandemic, the need to maintain financial flexibility during this period of elevated economic uncertainty, is crucial for the survival and ultimately recovery of companies. Balance sheet strength remains a fundamental priority, and the ultimate key for companies to weather the downturn and to be in strong position to generate shareholder returns in the long term.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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