Income Report / Income Report: How low will dividends go?

By Market Matters 06 May 20

Income Report: How low will dividends go?

Market Matters Income Report 6th May 2020

The ASX has opened lower this morning giving back some of the recent session gains. JB Hi-Fi (JBH) reported some strong sales numbers thanks to demand for electrical goods, retail investors are putting money back into the market as Magellan (MFG) reported net retail inflows of $175m in April after seeing $303m worth of outflows in March, while Bingo (BIN) is presenting today at the Macquarie Conference, and although they said the first 3Q were strong, they implied that Q4 was softer.

The ASX 200 is currently trading  down -44pts /-0.81% to 5363

ASX 200 Chart

The Income Portfolio added +0.76% for the week with strong performances by Smart Group (SIQ) which added +7.48% while MXT and NBI both paid distributions.  Financial year to date the portfolio has declined by -9.13% versus its absolute benchmark (RBA cash +4%) of +4.02%. Since inception, the portfolio has added +4.77% vs. the benchmark of +14.94%.  

How low will dividends go?

The size of the market rally we’ve seen from the March lows has been big, ~23% on the ASX 200 and more in some global markets. The rhetoric around economic data is distinctly bearish, the outlook for corporate earnings is dire and that obviously impacts dividends.

At MM we’ve been more positive than the headlines imply we should have been largely around the support of low interest rates and the huge wall of economic stimulus that was rolled out globally. Only yesterday the RBA has changed tack and will now accept corporate bonds as collateral when providing short term loans to financial institutions (prior to that, they would accept sovereign bonds, bonds from regulated banks and AAA rates asset-backed securities). The move is again designed to improve the flow of money around the system, which is its life blood. It’s this central bank support combined with the aggressive measures from Government and of course a better medical outcome to date in Australia at least that has helped the market.

However, while central banks and Governments are doing what they can, the fact remains that earnings have taken a significant hit and that will flow through to reduced dividends across the board.

To get a handle on dividends we need to understand earnings. Easier said than done at this point given a large proportion of companies have simply withdrawn guidance. If they don’t have enough confidence to predict their earnings what hope to do we have? That’s one of the reasons why at MM we tend to fall back on the technical’s at a time when fundamentals are so clouded.  

1.      Earnings

In the last 4 weeks consensus earnings expectations for the S&P/ASX 200 have been cut by 11.14%. At the index level, earnings per share (EPS) is now expected to be 294.92 for this financial year (FY20). With the index trading a around 5400, that puts the market on an estimated P/E of ~18.3x. The historical P/E of the market is around 14.5x making it expensive. However, earnings are meaningless in the short term and the level of uncertainty around what they’ll be is high – the highest I’ve seen. The banks for example have taken large bad debt charges based on best guess style scenarios and that feeds into earnings expectations, ultimately these charges could prove to be inaccurate on either side of the ledger.

Looking forward, EPS for FY21 is currently forecast to be 324.01 at the index level. This is growth of 9.86% which is about the longer-term average. It seems to me that analysts collectively have little faith in their predictive qualities at this point and have defaulted back to the historical average, which is probably the right approach. If the index produces 324.01 of earnings in FY21, the market is trading on a forward P/E of 16.69x, still expensive in absolute terms although less so considering how low interest rates are likely to stay.

2.      Dividends

In the last 4 weeks consensus dividend expectations for the S&P/ASX 200 have been cut by 16.75%, more than earnings expectations which is rare.  At the index level, dividend per share (DPS) is now expected to be 196.70 for this financial year (FY20). With dividends at 196.70 v earnings at 294.94, the markets payout ratio is ~67%, which is low relative to history. Assuming these numbers are correct, the S&P/ASX 200 is on a dividend yield of 3.64% this financial year, which is also low relative to history, and a low number relative to other asset classes like corporate bonds / hybrids and the like given the risks.

Looking forward, DPS for FY21 is currently forecast to be 217.48 at the index level. This is expected growth of 10.57% on the current year, above the longer-term average, implying a dividend yield in FY21 of 4.02% rising to 4.52% in FY22 i.e.  going back to normal. The payout ratio in FY21 remains around 67%. The market here is saying that payouts as a proportion of earnings will be lower than they have been historically. While that’s a bad thing for dividend investors, in a broader sense retaining more capital for growth should lead to an improvement in total return, which is the important number really. Outside of the banks, there are already companies ‘tweaking’ their dividend policies – Transurban an example of this which I’ll cover another time.

3.      Outlook from here     

At MM, we think earnings are meaningless in the very short term, so all this talk about an expensive market, high p/e’s at a time when economic conditions are contracting is irrelevant. However, earnings trends collectively over time will be key, and that’s a number we’ll continue to monitor and report on.  

While analysts are in downgrade mode, it’s hard to see the market moving substantially higher, instead we expect choppiness to play out at the index level as we get a better handle on how the earnings look on the other side on CV-19. It seems to me that picking the right sectors & the right stocks have never been more important.

Conclusion (s)

Take current earnings expectations with a grain of salt, we doubt anyone has a clear handle on this, including the companies themselves.

That means dividend expectations are very rubbery in the short term, however a market yielding 4.5% in the long term is about right.

Remain open minded about how the market performs from here.  

Have a great day!

James & the Market Matters Team


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