Investment Insights -
Sustainable dividends require active management
Dividends are an increasingly attractive way of generating an income, especially given the sharp fall in interest rates and term deposits. Furthermore, history has shown that dividend-paying companies tend to have defensive characteristics.
However, as the global economy remains vulnerable due to COVID-19, many companies face tough choices when it comes to returning cash to shareholders. Dividend cuts and suspensions have jumped. New Zealand companies have not been immune from this global phenomenon.
On the New Zealand share market, 22 companies have so far cancelled, deferred or reduced their dividend guidance since March 2020. Of these, 17 companies have cancelled (or expect to cancel) near-term dividends, three have deferred payments and two have signalled a reduction. This is not great news for income-hungry investors. Not only do shareholders miss out on a dividend, any cut or deferral is likely to be met with a fall in the share price. Relying on dividend income is not without risk.
For example, listed property company Kiwi Property Group, owner of the Sylvia Park and Northlands malls, made the decision not to proceed with its final dividend for the year ended 31 March 2020. This highlights the fact that many listed property companies pay dividends over and above their free cash flow, a situation that is unsustainable when economic conditions are uncertain.
Fletcher Building, New Zealand’s largest construction group, went further, announcing COVID-19 would likely have a significant impact on the markets in which it operates. Not only did they announce the cancellation of their 2020 interim dividend, they also suspended their on-market share buyback programme.
But there are rays of hope. Many companies remain committed to sustaining and even increasing their dividends. Spark, the telecommunications company, reaffirmed its dividend, while Chorus provided no change to its outlook and is one of the top performing shares in New Zealand this year – unsurprising, given broadband usage reached record levels over the lockdown period.
Assessing dividend sustainability – what to look for in the hunt for yield
As an active manager, NZ Funds’ research is focused on rigorously scrutinising balance sheet strength, financial conditions, and cash flow for each company we own to ensure the sustainability of dividends. And with good results – the top five high conviction holdings in the NZ Funds Dividend & Growth Portfolio, making up over 40% of the Portfolio, have all maintained their pre-COVID-19 dividends.
Looking forward, whether a company continues to pay a dividend can be partly answered by sorting it into three buckets. In the first are companies where dividend cuts will be required. Any firm that receives a bespoke or disproportionately large taxpayer bail-out will likely automatically fall into this category. Air New Zealand is an example. Taxpayers will be repaid before investors are entitled to any reward. So too for companies that are close to or are breaking their agreed debt covenants.
In the second bucket are companies that are stretched but believe that keeping up reliable dividends sends an important signal. The danger here is that they rack up debt to do so. The cash payments they promised shareholders were predicated on business-as-usual. We look to avoid these ‘dividend traps’ as there is no guarantee dividends will continue. As an example, Sky TV finally halted their dividend earlier in the year but not without long-term uncertainty.
In the third bucket are companies that have strong balance sheets and are operating near full tilt; for example technology firms and utilities. These are the companies we look to retain in clients’ portfolios.
Why active management is important
At NZ Funds we are unconstrained in our investment philosophy. We invest both passively and actively to gain the best outcome for clients. Right now, we believe it is imperative that active management forms the basis of clients’ investment management approach. The lacklustre outlook for dividends reflects the difficulty facing the global economy from COVID-19. More than ever, this divergence in dividend commitment from companies emphasises the need for share-specific research to help identify high-quality companies that can weather the storm.
Interest rates remaining ultra-low further underscores the need to find companies that can generate sustainable income for investors. NZ Funds’ active management across our income and dividend yielding strategies means we are well placed to generate income for our clients during the low interest rate environment.
However, as the global economy remains vulnerable due to COVID-19, many companies face tough choices when it comes to returning cash to shareholders. Dividend cuts and suspensions have jumped. New Zealand companies have not been immune from this global phenomenon.
On the New Zealand share market, 22 companies have so far cancelled, deferred or reduced their dividend guidance since March 2020. Of these, 17 companies have cancelled (or expect to cancel) near-term dividends, three have deferred payments and two have signalled a reduction. This is not great news for income-hungry investors. Not only do shareholders miss out on a dividend, any cut or deferral is likely to be met with a fall in the share price. Relying on dividend income is not without risk.
For example, listed property company Kiwi Property Group, owner of the Sylvia Park and Northlands malls, made the decision not to proceed with its final dividend for the year ended 31 March 2020. This highlights the fact that many listed property companies pay dividends over and above their free cash flow, a situation that is unsustainable when economic conditions are uncertain.
Fletcher Building, New Zealand’s largest construction group, went further, announcing COVID-19 would likely have a significant impact on the markets in which it operates. Not only did they announce the cancellation of their 2020 interim dividend, they also suspended their on-market share buyback programme.
But there are rays of hope. Many companies remain committed to sustaining and even increasing their dividends. Spark, the telecommunications company, reaffirmed its dividend, while Chorus provided no change to its outlook and is one of the top performing shares in New Zealand this year – unsurprising, given broadband usage reached record levels over the lockdown period.
Assessing dividend sustainability – what to look for in the hunt for yield
As an active manager, NZ Funds’ research is focused on rigorously scrutinising balance sheet strength, financial conditions, and cash flow for each company we own to ensure the sustainability of dividends. And with good results – the top five high conviction holdings in the NZ Funds Dividend & Growth Portfolio, making up over 40% of the Portfolio, have all maintained their pre-COVID-19 dividends.
Looking forward, whether a company continues to pay a dividend can be partly answered by sorting it into three buckets. In the first are companies where dividend cuts will be required. Any firm that receives a bespoke or disproportionately large taxpayer bail-out will likely automatically fall into this category. Air New Zealand is an example. Taxpayers will be repaid before investors are entitled to any reward. So too for companies that are close to or are breaking their agreed debt covenants.
In the second bucket are companies that are stretched but believe that keeping up reliable dividends sends an important signal. The danger here is that they rack up debt to do so. The cash payments they promised shareholders were predicated on business-as-usual. We look to avoid these ‘dividend traps’ as there is no guarantee dividends will continue. As an example, Sky TV finally halted their dividend earlier in the year but not without long-term uncertainty.
In the third bucket are companies that have strong balance sheets and are operating near full tilt; for example technology firms and utilities. These are the companies we look to retain in clients’ portfolios.
Why active management is important
At NZ Funds we are unconstrained in our investment philosophy. We invest both passively and actively to gain the best outcome for clients. Right now, we believe it is imperative that active management forms the basis of clients’ investment management approach. The lacklustre outlook for dividends reflects the difficulty facing the global economy from COVID-19. More than ever, this divergence in dividend commitment from companies emphasises the need for share-specific research to help identify high-quality companies that can weather the storm.
Interest rates remaining ultra-low further underscores the need to find companies that can generate sustainable income for investors. NZ Funds’ active management across our income and dividend yielding strategies means we are well placed to generate income for our clients during the low interest rate environment.
Source: NZX, Forsyth Barr 11 May 2020, NZ Funds research.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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