First, the coronavirus slashed share prices. Now, it’s triggering dividend cuts, prompting investors to look for sectors that offer reliable income streams in times of trouble.
With major parts of the economy grinding to a halt and no visibility on how long the shutdown will last, many companies are reducing or eliminating dividends to conserve cash as the pandemic shows no signs of slowing.
In the United States, companies that have suspended dividends include Boeing Co. (BA), Delta Air Lines Inc. (DAL) and Ford Motor Co. (F). Others, including Occidental Petroleum Corp. (OXY), have chopped their payouts.
“More cuts and suspensions are expected as companies move to limit expenses [and] cash flow declines,” said Howard Silverblatt, senior index analyst with S&P Dow Jones Indices. The last time dividends for S&P 500 companies fell in aggregate was in 2009, when payouts plunged about 21 per cent. "It is very feasible that we will see a decline” in 2020, he said.
In Canada, the combination of low oil prices and business shutdowns to limit the spread of the coronavirus has led to numerous dividend cuts in the oil patch. Other sectors are also getting hit hard. With governments ordering restaurants to close their dining rooms, at least two restaurant royalty trusts – Boston Pizza Royalties Income Fund (BPF.UN) and SIR Royalty Income Fund (SRV.UN) – suspended distributions this week. Powersports vehicle maker BRP Inc. (DOO) also suspended its dividend, while bus maker NFI Group Inc. cut its payout in half as it permanently laid off 300 employees in Winnipeg and announced two-week plant shutdowns that will affect thousands of other workers.
Even as the number of companies cutting dividends grows, analysts say certain sectors offer relative safety for income seekers. Canadian banks, for example, are unlikely to cut their dividends given their strong capital levels, although the relative safety of their dividends should be balanced against the possibility that the bank stock prices could fall further if the pandemic worsens.
“We believe it is too early to aggressively buy Canadian bank stocks. We want to be more certain of the depth and length of a recession and that global liquidity issues do not result in some form of contagion that could cause significant write-downs or other issues for the banks,” RBC Dominion Securities analyst Darko Mihelic said in a March 23 note.
But dividend reductions are “very unlikely” given the banks’ financial strength, Mr. Mihelic said. As of the first quarter, the large Canadian banks (excluding Royal Bank, which RBC does not cover) had an average Common Equity Tier 1 capital ratio of 11.5 per cent – well above the current minimum CET 1 ratio of 9 per cent required by regulators. This indicates that the banks are in a strong position to absorb credit losses and ride out the crisis.
Regulators have the ability to drop the minimum CET 1 ratio to 8 per cent, but if any bank were to fall below that level a dividend cut would be unavoidable. However, the chances of that are remote, Mr. Mihelic’s analysis shows.
“Based on our calculations, earnings for the large Canadian banks under our coverage can cumulatively be impacted by [about] $130-billion before the banks each reach a CET 1 ratio of 8 per cent,” he wrote, calling the dollar amount “almost unfathomable.”
James Hymas, president of Hymas Investment Management, said the risk of banks cutting dividends is “so small that it cannot be quantified.”
“The saving grace in all of this is that after the credit crunch the regulators really went to town, insisting on higher capital levels," Mr. Hymas said in an interview. “So the banks have an enormous shock absorber … in terms of their capital and their size and their protection from competition.”
Still, investors accustomed to getting regular dividend increases from the banks will have to lower their expectations. In exchange for loosening the banks’ capital requirements recently in an effort to help the economy, the Office of the Superintendent of Financial Institutions told banks to refrain from using the freed up money to increase dividends or buy back shares.
Other sectors that will likely be spared from dividend cuts include telecom companies, utilities, pipelines and power producers, analysts say. These sectors benefit from contracted or regulated cash flows that provide stability in challenging economic times.
In a note on Wednesday, Raymond James analyst David Quezada said independent power producers of renewable energy are largely insulated from the coronavirus shock. “The renewable IPPs face little exposure to an economic downturn or lower power demand with largely contracted revenues, abundantly manageable debt loads, limited near term [debt] maturities, secure dividend payouts, and what remains a lengthy runway of growth opportunities in key regions,” he said.
“While certain construction projects may see delays as contractor safety is prioritized, we regard current operations for these companies as highly stable,” Mr. Quezada said. He upgraded his ratings on TransAlta Renewables Inc. (RNW), Capital Power Corp. (CPX), Innergex Renewable Energy Inc. (INE) and Boralex Inc. (BLX).
Telecom dividends should also hold up during the pandemic, analysts say, given that people are using their smartphones more than ever to stay in touch.
“Given we expect telecom revenues to remain reasonably resilient as the Canadian economy potentially enters recession, we do not foresee a scenario whereby balance sheets (including liquidity) and current dividends come under pressure or into question,” RBC Dominion Securities analyst Drew McReynolds said in a March 17 note.
Full disclosure: The author owns banks, telecoms, power producers and pipelines personally and in his model Yield Hog Dividend Growth Portfolio.
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