In their most recent regular study “UK Dividend Monitor”, Link Group* announced that they were ‘withdrawing [our] formal forecast for dividends in 2020 until the depth and duration of the lockdown and associated economic impact becomes clearer’. In the study, the scale of the challenge for dividend investors was very clear; to the 5th April 2020, 45% of Britain’s listed companies had already cut/cancelled their dividend or were certain to do so. The biggest impact has come from Banks, none of whom will be paying a dividend this year (worth over £13bn to investors).
The management teams and boards of many companies are feeling that it is prudent to cancel dividends that were due to be announced or paid during lockdown and look again at the situation later in the year. This is the case even for those that clearly have the balance sheet and liquidity to pay them. Whilst the current uncertainty warrants financial prudence, a key factor in these decisions has been the political and social perspective. In particular, it is difficult for a company that is making use of furloughing or other forms of government aid to announce a dividend during lockdown.
The situation is not all doom and gloom for dividend investors however. Some businesses are quite insulated from the crisis and others even thrive. Hardest hit sectors include airlines, leisure, travel, oil and mining. More resilient sectors include consumer branded goods, technology and healthcare. In these sectors many companies will either maintain their current dividend or in some cases may even grow them over the coming year.
Here at Evenlode we have always focused on investing only in market-leading, cash generative stocks and deploying a disciplined valuation and dividend filter, a patient mindset and ongoing management of fundamental risk. The Evenlode Income Fund portfolio entered the crisis with a healthy level of free cash flow cover relative to dividends, some very strong balance sheets across the portfolio and a bedrock of repeat-purchase business models. And the long-term structural positioning of the fund means that we will never have positions in certain sectors or industries such as banks, utilities, energy, mining and telecommunications. These sectors make up a large part of the UK market and are also some of the hardest hit sectors for dividend cuts.
However, the fund will not be immune to the current dividend situation and we do expect the income stream to fall in the short-term. For reference, cancelled/postponed dividends in the fund that have been announced (as at 22nd April 2020) account for c.25% of the dividend stream for the fund’s current financial year (to February 2021). This includes assumptions for certain companies that we expect will also choose to pass dividends for the rest of the year, but there may be some further announcements relating to dividend disruption in coming weeks. Offsetting this risk somewhat, and based on management comments, a portion of these disrupted dividends may be paid later in the year. Looking further ahead, the portfolio is focused on market-leading businesses that we think will be able to endure this crisis and, in many cases, emerge with their competitive positions strengthened. This should bode well for free cash flow and dividend growth if one looks past the immediate crisis to the longer-term.
As a broader point, investors should be aware of the behaviour of individual companies during the global pandemic as actions taken now will have direct ramifications for their reputation in the coming years. The fortunes of a business are dictated not only by the shareholders and management, but also by relationships with customers, suppliers, employees and society at large. A company’s long-term profitability is dependent upon maintaining a balance with these groups. Companies that adopt a positive approach in their responses to the pandemic are demonstrating a commitment to the long-term. For long-term investors such as Evenlode, our view is that the “right thing” is most often the “profitable thing” in the long-term. As former Intel CEO, Andy Grove, put it “bad companies are destroyed by crises; good companies survive them; great companies are improved by them”.
* Link Group: UK Dividend Monitor, Issue 41 Q1 2020
Written by Hugh Yarrow, Fund Manager, Evenlode Income Fund
Views and opinions have been arrived at by the author and should not be considered to be a recommendation or solicitation to buy or sell any products or securities that may be mentioned.
Illustration by Darren Richards