To pay or not? The dividends debate

Australian companies that are in good financial shape have been urged by one fund manager to keep on paying dividends to support retirees, while other commentators believe companies receiving government covid-19 aid should pause dividends.

Fund manager Martin Currie has this month sent a letter to the chairperson of every major company in which their equity income portfolios invest, urging them to keep paying dividends.  The pandemic has pushed interest rates down, and for retirees who depend on dividend income, their financial situation has suffered.

“It concerns us to hear that many of the high quality ASX-listed companies that we invest in for our clients are equivocating about whether to pay dividends, even when they do have sufficient cashflow and means to pay those dividends,” the letter from the chief investment officer Reece Birtles and portfolio manager Will Baylis said.

“For the investee companies in our Income portfolios, our message is clear—if a company has reasonable cashflow and a sound financial position, dividends should be paid.”

In such difficult economic times, and with an uncertain market outlook, the letter’s authors said the benefits of dividend income and franking credits to retirees cannot be underestimated.

“Retirees are key beneficiaries of these dividends, and they have worked hard to have sufficient capital to fund their own retirement. Charities and foundations, similar to retirees, also depend on dollar income to fund their own outgoings, most of which benefits society in the form of hospitals, scholarships and other charitable causes,” Birtles and Baylis said.

However, not everyone agrees. Todd Hoare, head of equities, Crestone Wealth Management, says companies are not responsible for the redistribution of wealth to help retirees—that is a government decision made possible through taxation and welfare payments.

“Calling for companies to also be a part of this redistribution could quite possibly have unintended consequences, such as lowering company growth rates or increasing discount rates, offsetting any benefits of a near-term dividend boost by lowering longer-term capital gains,” Hoare said.

“The decision to pay a dividend is a capital allocation one that must consider multiple, and competing, uses of that capital and the likely returns on that capital, including dividends, buybacks, capex and merger and acquisitions,” he said.

The financial regulator has recently asked banks to cap dividend payout ratios at 50 per cent of earnings for the rest of the calendar year, which represents a softening of APRA's April edict to "defer" or "materially reduce" the payments.  The Commonwealth Bank (ASX: CBA) this week announced it would pay a final of 98 cents a share, a drop of 57 per cent from the $2.31 it paid in the previous year.

According to a recent survey from the CFA Institute of its members worldwide, including fund managers, 82 per cent of Australian respondents believe companies that receive emergency support during the crisis should not pay dividends or compensate executives with bonuses, compared to 75 per cent globally.

Hamish Tadgell, portfolio manager, SG Hiscock & Company, says if a company has focused too much on paying dividends, this can lead to perverse behaviour in terms of issuing capital or borrowing just to fund dividends.

“Dividends are only sustainable if they are paid out of sustainable free cashflow, and companies invest appropriately to develop and maintain their competitive position and grow," Tadgell said. "The covid crisis has exposed where dividend payout ratios are unsustainable."

• MORE ON THIS TOPIC: Where dividends might grow from here

AMP Capital Australian Equities portfolio manager Dermot Ryan says dividend payments are down about 40 per cent from this time last year after an over $300 billion working capital squeeze.

“When choosing stocks in this environment it’s important to consider the balance sheet strength and the ability of that company to work through the covid-19 pandemic," Ryan says.

"There are some interesting opportunities in areas of the market where dividends have been cut to zero as there are some good companies who will able to surprise on dividends as the economy reopens.”

Caution needed for companies under stress

Academics at RMIT University’s School of Management, Andrew Linden and Warren Staples, believe where the solvency of corporations is in question, companies should not prefer shareholders over creditors and employees by paying dividends, buying back shares or borrowing to pay dividends.

“Directors have a legal obligation not to trade while insolvent. Not having enough cash on hand to pay bills as and when they fall due triggers this obligation,” Linden and Staples say.

“In times of crisis where the solvency of corporations is a live question, preferencing shareholders over creditors and employees by paying dividends or buying back shares or borrowing to pay dividends is likely to be a breach of duties because it sucks even more liquidity out of the business and increases leverage.”

According to SG Hiscock’s Tadgell, better-managed companies understand the benefits and value in retaining staff through this crisis, rather than paying dividends to shareholders.

“This may come at some cost in the short term, including prioritising employees over dividends, but with the benefit in building employee engagement, loyalty and culture and ultimately longer shareholder value. SEEK (ASX: SEK) is a good example of a company which has done this, and it is likely to emerge from the crisis stronger as a result.”

But if a company can afford to, paying dividends isn’t a bad thing, especially if they can take advantage of opportunities to expand, says Crestone’s Hoare.

“The ‘winners’ post covid-19 are likely to be those companies that have proven business models and balance sheets that allow them to invest through the cycle, taking advantage of the failings of competitors. If that level of profitability also supports the continued payment of dividends, then all the better."

This article is part of Morningstar's Reporting Season 2020 coverage. The calendar will be updated daily to connect you with our equity analysts' take on the financial results.