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Coronavirus: dividends are at risk

Glenn Freeman  |  26 Mar 2020Text size  Decrease  Increase  |  
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Listed property, banks and energy companies are among the biggest coronavirus losers to date, so you might need to temper your expectations for cash distributions in fiscal 2020, says Morningstar.

Dividends and real estate investment trusts go hand-in-hand, as part of the so-called "bond proxy" cohort of defensive sectors. They're viewed as defensive because of the relative stability of corporate rent. And for this reason, REITs are regularly targeted by investors chasing yield and more stable earnings growth.

But without rents, you don't have REITs.

These are discussed in a special coronavirus report by Morningstar's global team of equity analysts.

For access to a list of 40 best ideas named in the report, Coronavirus: Market Temperature Check, subscribe to Morningstar Premium or take a free trial.

Year-to-date performance of REITs

Energy sectors

Australian property play Mirvac (ASX: MGR) highlights the importance of rents to REITs. Rent from commercial buildings comprises around 60 per cent of the property developer's earnings—this includes across retail (30 per cent) and industrial (8 per cent).

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Morningstar analysts are most positive on dividends over the shorter-term within this category of REITs.

"In a less severe downturn, industrial REITs may see improved performance as demand for warehouse space becomes even greater."

More broadly, Morningstar's analysts don't believe REITs "will want to do something that causes long-term damage to their image with investors, given the short-term nature of the disruption."

Morningstar analyst Alex Prineas believes a lot of REITs will cut dividends, particularly those exposed to retail or cyclical areas such as housing development.

Premier Investments - again, not named in the report - is one example of the risks retail landlords face. The parent company of several large retail brands Just Jeans, Portmans and Smiggle will shutter its Australian stores on the evening of Thursday 22 April, standing down most of its 9,000 staff.

The biggest shock: Lew says Premier won't pay any rent during the shutdown.
But even amid such measures, Prineas says: "A lot of it depends on what type of government package there is, and how long the virus shutdown lasts. At the moment, we don’t know the answer to that," he says.

"But if you're investing in REITs this year, be aware dividends could be at risk."
Prineas also singles out listed property stocks in the hospitality and pubs segment. In the US and other markets, these types of businesses have been forced to close. Similar measures are being rolled out locally.

"But it's important to remember that we do expect eventually to return to a normal situation," Prineas says.

"As long as the REITs survive without massive capital raisings, then any cancelled dividends should resume."

Bank dividends

Banks are also prized for their dividends by many investors.

Morningstar analysts from the US and Asian teams say that for banks, dividend sustainability essentially comes down to two things: net income and capital.

"While it is admittedly tough to tell what the fallout will be from the coronavirus, at the very least we can say that the banks are much better positioned today than they were during the financial crisis," say the bank analysts.

For dividends to be under threat, we'd need to see a "severe recession" causing banks' net income to fall at least 40 per cent. And this isn't the most likely scenario. This is a view shared by Morningstar Australia's banks analyst Nathan Zaia. It's going to be bad for the banks, as it is for everyone, but not as catastrophic as investor reactions might suggest.

"A recession will bring pain to banks' earnings, but just as in the past, the banks are strong enough to get through," Zaia says. But at the same time, caution is advised.

"While we appreciate the franking credit benefits and the relatively high yields, investors should be mindful volatility in earnings will be reflected in dividends," Zaia says.

"Banks are cyclical businesses exposed to the health of the economy."

At least one of Australia's major banks has taken the opportunity to cut their dividends more than the other big four—as detailed in the report. International Morningstar analysts say: "most excess cash has been used to make share repurchases, and the banks can easily stop these repurchases if earnings start coming under severe pressure.

Oil dividends

And finally, oil and gas dividends are relatively safe for now, says Morningstar Australia senior equity analyst Mark Taylor. This is despite the pain endured by energy companies in recent weeks as the oil price has crashed.

A double-whammy effect occurred as coronavirus hit demand, and the largest OPEC producers Saudi Arabia and Russia responded by refusing to cut output, in turn prices plunged.

Brent crude is currently trading at US$27.60 a barrel, from US$55 a month ago.
In the shorter term, Taylor has slashed his dividend per share forecast for Australian exploration and production companies by between 50 and 70 per cent for fiscal 2020.

Morningstar anticipates oil prices will bounce back to around US$40 a barrel through 2021. On a global level, debt levels among the biggest offshore exploration and production companies aren't expected to blow out, say Morningstar analysts.

"Even the highest levels [of debt we foresee] remain manageable…so dividend cuts are unlikely, in our opinion," says Taylor.

Morningstar's energy analysts are also buoyed by the low debt levels among the largest offshore exploration and production companies.

"But for other oil and gas sub-industries, there is absolutely a risk of cuts to even the modest dividends that are paid," Taylor says.

Other types of companies within the sector—fuel refineries, for instance—generally have smoother cash distributions. "But this time it's not so assured," Taylor says.

"As such, we think energy stocks are oversold, creating a buying opportunity. But we caution that the probability of things getting worse before they get better is not trivial."

The report chapter referenced here includes contributions from analysts: David Meats, CFA; Kevin Brown, CFA; Eric Compton, CFA, Yousuf Hafuda; Chok Wai Lee; Michael Wu, CAIA; Iris Tan, CFA; and Michael Makdad, CFA.

is senior editor for Morningstar Australia

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