With the coronavirus pandemic sending shock waves through the economy, readers have asked me: How sustainable are the dividends in your model Yield Hog Dividend Growth Portfolio?
Let’s get the bad news out of the way first.
One of the model portfolio stocks, A&W Revenue Royalties Income Fund (AW.UN), temporarily suspended its monthly distribution this week. The move wasn’t surprising given how the pandemic is hammering the restaurant industry. A&W has closed about 200 of its 996 restaurants across Canada and, with only drive-through, delivery or mobile order pick-up available at certain locations, “customer traffic … is down significantly as more guests remain at home and exercise social distancing,” it said.
No other stocks in the portfolio have cut their dividends yet and, while nothing is guaranteed, I am hopeful that most of the payouts will be maintained. For the analysis that follows, I’m relying on an RBC Dominion Securities report titled “Dividend Sustainability in Canada." The report examined how dividends are likely to fare in 2020 and 2021 “in the context of a deep contraction in economic activity over the next three to six months, followed by a gradual recovery thereafter.”
Power, utilities and pipelines
Power producers, utilities and pipelines provide essential services, and they benefit from earnings that are either regulated or contracted on a long-term basis. This predictability gives their dividends a high degree of stability, even during tough economic times. “We believe the historical trend of dividend stability and regular annual growth is likely to continue for the vast majority of the companies that we cover,” RBC analyst Robert Kwan said. The eight power, utility and pipeline stocks in my model portfolio all received a dividend stability rating of “high” from RBC. They are Algonquin Power & Utilities Corp. (AQN), Brookfield Infrastructure Partners LP (BIP.UN), Canadian Utilities Ltd. (CU), Capital Power Corp. (CPX), Emera Inc. (EMA), Fortis Inc. (FTS), Enbridge Inc. (ENB) and TC Energy Corp. (TRP).
During the pandemic, people are still using their cellphones, surfing the internet and watching TV – perhaps more than ever. What’s more, “all Canadian telecom operators have strong balance sheets and substantial access to liquidity,” RBC analyst Drew McReynolds said. These companies also have the flexibility to cut costs and reduce capital spending to sustain dividends in a severe economic downturn, he said. The two telecom companies in my model portfolio – BCE Inc. (BCE) and Telus Corp. (T) – earned a “high” dividend sustainability rating from RBC, as did the other major Canadian cable and wireless players.
Dividend cuts by Canadian banks are rare. “Since the 1940s, only National Bank cut its dividend (in the early 1980s and again in the early 1990s),” RBC analyst Darko Mihelic said. Even during the 2008-09 financial crisis, Canadian banks held their dividends steady but put increases on hold for several years. Still, if a bank’s capital levels were to fall below certain regulatory thresholds they would have no choice but to cut. But Mr. Mihelic said banks could choose to raise equity to avoid this, “even though this act could be potentially quite dilutive and not conventionally in keeping with ‘sound’ financial theory." RBC assigned a “high” dividend sustainability rating for the major banks, including three of the four members of my model portfolio – Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CM) and Toronto-Dominion Bank (TD). (RBC Dominion Securities does not cover parent Royal Bank of Canada (RY), which is the fourth bank in my model portfolio, but I’ll assume its dividend is as secure as the others.) RBC also gave a “high” sustainability rating to Manulife Financial Corp. (MFC), the sole insurance company in the portfolio.
Real estate investment trusts
Payout ratios are likely to rise – in some cases exceeding 100 per cent of adjusted funds from operations – as REITs offer rent deferrals or abatements to financially stressed tenants, RBC analyst Neil Downey said. REITs that are heavily exposed to discretionary retail categories or that have significant operations in Alberta “are likely to face some of the greatest challenges,” Mr. Downey said. Overall, however, most REITs “will endeavour to hold cash distribution rates constant, while funding short-term deficits with available liquidity,” he said. Three of the four REITs in the model portfolio – Canadian Apartment Properties REIT (CAR.UN), Choice Properties REIT (CHP.UN) and CT REIT (CRT.UN) – earned a “high” dividend sustainability rating from RBC. The fourth – SmartCentres REIT (SRU.UN) – received an “average” rating.
RBC doesn’t cover Restaurant Brands International Inc. (QSR) – the other fast-food stock in the model portfolio. I expect that the company will address the dividend when it reports first-quarter results in the next month or so.
Even in an unprecedented crisis such as this, many companies will continue to pay dividends. Others will cut or temporarily suspend payouts to conserve cash, which for A&W was the most prudent course. The key thing to remember is that the pandemic will pass, life will eventually return to normal and strong companies will continue to prosper.
E-mail your questions to email@example.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.