Dividend cuts have started – should you sell now?
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Associate Editor
David Stevenson Nov 27, 2008
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DSG: one of many companies to scrap dividend payments
What do pub owner Mitchells & Butlers (LSE:MAB), concrete supplier Ennstone (LSE:ENN), Hovis and Mr Kipling baker Premier Foods (LSE:PFD) and Topps Tiles, the UK's biggest speciality tile retailer, have in common?
Answer: within the last week, they've all cancelled dividend payments. What's more, today DSG (LON:DSGI) - owner of Dixons, Currys and PC World - has just done the same. And as the economy goes from bad to worse, we can expect a torrent of such headlines as company profits come under pressure and cash flow runs low.
But what does that mean for investors? The obvious reaction to a dividend being slashed is that it's time to avoid or sell off the stock. But that's not always the case...
We have yet to see massive cuts in dividend payouts...
We've been worried for some time about how company cash flows are increasingly becoming a major casualty as Britain enters recession (see our recent MoneyWeek article: Companies are leaking cash - that's bad news for jobs).
And no one's even attempting to deny anymore that a recession is well and truly upon us. Yesterday, data from National Statistics confirmed that UK GDP – gross domestic product, i.e. annual output - dropped by 0.5% over the quarter to the end of September compared with the previous three months.
As Howard Archer at Global Insight puts it: "while contraction in the third quarter doesn't put the UK officially into technical recession yet, it's impossible to dispute that we're there".
Consumer spending fell 0.2%, construction subsided 0.7%, industrial production slid 1.1% and business investment tumbled 2.4%. That sounds bad enough – but remember that those figures are almost two months out of date.
"The economy has just fallen off a cliff", says Neil Mackinnon at ECU. "The prospects for the next couple of quarters aren't great."
That sounds like a supreme piece of understatement. From the tone of the trading updates we've been seeing recently, UK Plcs are clearly already suffering. But what's interesting is that we haven't yet seen a huge impact on dividend payouts.
...but that's set to change soon
I've been looking through the future dividend calendar to see what's on the cards. Yet according to Bloomberg data, just 12 of the 240 or so companies that are due to report their earnings within the next two months have so far said that the next payment will be scrapped. Several dividends have been trimmed, but there's been no widespread massive damage yet.
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That almost sounds reassuring. Until you realize that a full 75% of those pulled payouts were revealed only during the last week. In other words, it's looking like we could be facing a tsunami of ditched dividends.
We only need look to the US for an idea of what could be about to hit us. "Stock dividends are disappearing at the fastest rate in 50 years", say Lynn Thomasson and Eric Martin at Bloomberg.
No fewer than 91 US-listed companies are either cutting or suspending their payouts to shareholders this month. That's the worst monthly result since May 1958, when 113 companies slashed dividends, according to Standard & Poor's, with the November dividend reductions far exceeding the 81 cuts in October and the 60 in September.
Nor is there any prospect of this nasty trend reversing soon. Overall company profits are down for the fifth straight quarter, which leaves less spare cash for payments to shareholders.
"Until we start to see the economy turn around", says Fritz Meyer at Invesco Aim Advisors, "you have to assume broadly that dividends could be at risk in many sectors of the economy, especially among financials".
That will soon apply over here, too. So not only have most shares collapsed in value, but also the tangible returns from holding many of them, i.e. a stream of income, could well be about to evaporate, too.
Why a dividend cut doesn't always mean sell
So if you're still a shareholder in a company which decides to scrap its dividend, does that automatically mean you should dump the stock straightaway?
No. Not necessarily.
Each individual case is different. Ultimately, it all comes down to cash flow. While sometimes the cancelled payout can indicate the beginning of the end, it can also be a signal that a company is taking sensible measures to conserve cash to help it through the tough times – and that somewhere on the economic horizon, the firm's fortunes are going to improve.
So the share price could by now be 'pricing in' much of the bad news and might be about to bottom out. It could even be time to buy some more shares.
For now, we'd still avoid piling into the most vulnerable sectors – such as retailers, financials, and anything consumer-facing – which will be among the first wave of big dividend cutters.
But if you want a step-by-step guide to the signs you should look for to judge in which camp a company falls, look out for Tim Bennett's piece in tomorrow's issue of MoneyWeek (if you're not a subscriber, get your first three issues free here), on the 'red flags' that warn you a company is in real danger of going to the wall.
Interested in using a dividend-paying strategy for your investments? Take a look at The Dividend Letter. Written by MoneyWeek contributor Stephen Bland, this investment newsletter outlines a hugely successful long-term strategy which aims to identify shares that will pay out large dividends.
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