Dividend payments are diving: what can you do?
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Associate Editor
David Stevenson Apr 16, 2009
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Dividends are just about the only thing you actually get from owning shares.
But the dividend scene's not so hot right now. In the States, this year's first quarter was the worst for payouts since at least 1955. And next year could be even worse. Meanwhile, a British dividend drought is developing, too.
So what should income investors do to find safe dividend payers? How about a new method: check out the credit markets.
The worst dividend payments for over 50 years
"Dividends matter", says Investors Chronicle, "virtually every long-term study of total returns indicates that dividends account for almost two-thirds of gains. But markets are predicting a new dividend Ice Age, with payouts abandoned and yields collapsing".
So there's trouble ahead for investors wanting income. Just look at the States, where 5% of quoted companies cut their dividend payments in 2009's first quarter, says Standard & Poors. Those are the worst figures since data began in 1955. Investors have been hit to the tune of $77bn. In addition, payout decreases have exceeded increases: increases amounted to just 4% of the overall payment total.
Even worse, says S&P's Howard Silverblatt, if companies don't feel happier about their finances later this year, another round of dividend cuts is on the cards in 2010.
Meanwhile, only 59% of FTSE100 companies upped their payouts - compared with 80% in 2008 - in this year's first quarter, which was one of "the most catastrophic in the history of dividends", says Markit. 11% of FTSE100 stocks slashed their payments, while some 12% axed payouts completely. The year-on-year total was slashed by a third. So despite the FTSE100 falling by that amount since April 2008, it yields no more now than it did 12 months ago.
More pain in the payout pipeline is a cert. So if you really need dividend income, and want to avoid stocks about to chop what they pay, what should you do?
Which companies could cut their payments?
Firstly, remember that yields on shares rise, i.e. prices fall, when the market 'discounts', i.e. factors in, an increasing risk of non-payment. So high-yielding stocks are generally more likely to suffer payout cuts. And the main reason for dividend disappointments is when earnings get crushed.
One way to anticipate this is to scour credit reports. Sounds boring, I know. But these spotlight industries developing financial problems, and pinpoint firms that are becoming more likely to default on their bond borrowings. And any business having trouble paying the interest on its corporate debt – which ranks ahead of stock dividends in the payment pecking order – clearly isn't too well placed on the share payout front. Conversely, where an industry's outlook is improving, there's more chance of good dividend news.
Right now there's plenty to worry about. 27% of the companies on Moody's latest global list are currently rated negative, which means things are getting worse, with an extra 10% of firms on downgrade review, i.e. a credit rating cut could be on the cards. And what's very scary is how fast the corporate scene's going sour. Moody's reckon that a whopping 21% of European so-called 'junk'-rated bonds won't make their interest payments by the end of 2009. Putting that into context, the default rate in Europe just over a year ago was a mere 0.7%.
S&P are fast catching up, this week raising their own European default estimate to 15% for 2009.
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Top of the industry 'avoid' list – i.e. where Moody's has been sharpening its downgrade pencil – is the airline business. Over 60% of quoted global airline stocks have a negative rating, with a further 13% on 'review for downgrade'. And other industries giving Moody's the jitters, i.e. where least 40% of the companies monitored either have been or could be downgraded, are building materials, cars, hotels, property, construction, media, life assurance, finance - the list just goes on.
Of course, this is an ultra-cautious way of measuring dividend risk. Some stocks even in the most "suspect" sectors will still at least maintain their dividends. And as Markit's Ryan Bransfield points out, "one striking feature of this earnings season's dividend announcements has been the payout differences for companies in the same sector. Almost everywhere we saw companies slashing payouts due to debt, diminished demand or simply prudence in the face of uncertain future cash flows".
But being very careful these days tends to pay off. Which brings us to the - relatively - good guys. So which are the industries with almost as many positive prospects as negative?
Two stocks where dividends look secure
There are just two: aerospace & defence…and packaging.
Even within these, not every company will be a guaranteed safe payer. But here are a couple of stocks whose yields aren't the highest, but where the dividends payments do look secure.
We highlighted BAE (LSE: BA) two months ago, since when the shares have slipped 15% on American defence spending uncertainties. But last week the US Defence Secretary largely knocked those fears on the head as far as BAE is concerned. On a 2009 p/e of 8.3x - around half their usual rating - with double digit-earnings growth and a 4.5% dividend yield, "unless you predict world tensions are going to ease significantly" – hardly likely – "over the next ten years", says the Telegraph's Questor, "the shares are a definite buy".
As for packaging, take a look at Austrian carton maker Mayr-Melnof Karton (AV: MMK). Last week the company said that 2009's first quarter was better than the end of last year. With net cash in the balance sheet, strong cash flow, a prospective 3.3% yield and the shares down 40% from their highs of two years ago, this could be a great time to get on board.
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