Covid-driven market gnaws at Reit dividends
The Covid-19 outbreak and subsequent economic fallout have resulted in many companies opting not to pay dividends because their operations have been heavily disrupted or are expected to be disrupted in future.
Some companies, including those with a good track record of paying dividends, have opted not to pay dividends simply because the operating environment is uncertain, and they believe it is prudent to rather preserve cash. Others (such as the banks) have been directed by regulators not to pay dividends in the near term.
In the case of real estate investment trusts (Reits), many companies have opted to delay distribution payments and even declarations thereof. The sector has been hard hit by the fallout from Covid-19 — particularly those Reits that have high exposure to the retail and office sectors.
For equity and property investors, dividends and distributions form an important part of the “total return profile” of a stock. For many individual investors, dividends also provide a semi-annual cash flow return on investment taxed at the withholding rate of tax, often lower than the investor’s marginal tax rate.
An individual’s return in investing in any company or Reit is a function of the change in the stock price and dividend. The dividend tends to be the more predicable source of return or cash flow that investors can use to draw an income. In fact, over the last five years the bulk of local equity returns has been driven by dividends, as aggregated share prices have moved largely sideways.
Some companies and Reits are still paying dividends and distributions and others are planning to resume dividend payments soon. However, there has been a structural shift for some companies that could derail dividend payments for some time. While avoiding the latter is key, the risk for current dividend payers, and even the companies planning to resume dividend payments soon, remains a prolonged economic downturn that will influence the dividend profile.
Broadly speaking, Reits could receive temporary relief from a regulatory perspective but could be compelled to resume dividend payments over the next 12 months. Even with a sharp reduction in estimated distributions over the next 12 months, prices seem to more than reflect this near-term reduction. We have seen some Reits pay distributions, particularly in niche sectors, while others have reduced dividend payments to 75% of distributable income to comply with regulations.
Resources companies have been able to pay dividends as a result of super-profits being earned in several subsectors. This could change quickly — while most of these companies are in better financial nick than in the previous commodity price downturn, their ability to pay dividends is inherently cyclical.
Financials shares, particularly banks, should be able to resume paying dividends as soon as the prudential authority gives them the go-ahead. These dividends could be a lot lower than usual due to what could be a deterioration in base profitability.
Industrial companies have been a mixed bag; certain companies such as British American Tobacco have not seen a major effect on cash flow and have continued paying dividends. Recently some companies (AECI and Pick n Pay being prime examples) have declared backdated dividends or may do so should conditions in the relevant industry normalise. Overall, however, we could see dividends from the sector come down as companies opt to rather use excess cash flows to pay down debt.
The table shows that the JSE overall is now trading at a lower forward dividend yield than at the end of 2019. This is because the index movement has disconnected from the reduction in expected dividend payments 12 months ahead. This has been driven by the industrial and financial sectors.
Reits have shown the opposite, meaning the reduction in share prices has exceeded the expected decline in dividends over the next 12 months. This reflects heightened forecast risk, but it can also be argued that the market is complacent on the issue. It is important to remember that the market discounts cash flows into perpetuity and it is therefore not necessarily correct for share prices to decline in line with dividend expectations just one year out — particularly if even a partial recovery in dividends is anticipated.
The break in dividend payments and Reit distributions will be disruptive to near-term return profiles, and particularly concerning to income portfolio investors. However, the break in regular dividend and distribution payments is likely to be temporary for many companies and Reits.
The trick is to identify companies (Reits) that are either still paying dividends (distributions) and will continue to do so, and companies that may have halted dividend payments (whether by force or for the sake of prudence) but will resume dividend payments soon. While absolute dividend payments could be lower, the share prices could in many instances be fully reflecting this.
• Marx is head of research at FNB Wealth and Investments.
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