(Source: Plato, Bloomberg, *RBA)

Earlier this year as the pandemic took hold, we predicted dividend income would fall by around one third across Australian equities over 12 months compared with pre-COVID levels. This fall is similar to the fall in dividends during the last recession Australia faced, the “recession we had to have” in 1990-1991. 

The difference this time is the sharp fall in dividends already seen this year is expected to be relatively short-lived, when compared to the early 1990s. Then, dividends slumped over an extended 3-year period.

Globally attractive

Australia’s dividend outlook looks better than much of the world. Australia’s COVID impacts (ex-Melbourne) have been relatively moderate, when compared to the US, Europe and Brazil.  

Despite Australia successfully getting ahead of the COVID curve, the fiscal policy response from government has also been relatively large and swift when compared to other countries. We expect this to have a positive impact on our economy and much of our sharemarket.

Fortunately for ASX investors, the dividend cuts are likely to be mixed across stocks.  More than 20% of stocks Plato follows increased dividends in the August reporting season, despite a 30% average fall (in dividends).

Dividend opportunities

(Editor’s note: Do not read the following ideas as stock or dividend recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article).

First, and most importantly, we must identify the industries which are likely to cut dividends. 

The dividend cuts are stock and sector specific. This highlights the critical role of active portfolio management and the current risks associated with index investing as well as using simple metrics like historical dividend yield to forecast dividends. 

Financial institutions, retail Australian Real Estate Investment Trusts (AREITs), travel and tourism are the hardest hit industries. Most companies in these industries have already cancelled or deferred dividends.

Logically, the final process in reopening our economy will be opening up our borders, so we’d expect anything associated with international tourism to be the biggest losers. Qantas Airways (ASX:QAN) will benefit somewhat from a weakened competitor in Virgin Australia Holdings (ASX:VAH), but we expect Qantas and the likes of Sydney Airport (ASX:SYD), Webjet (ASX:WEB) and Flight Centre Travel Group (ASX:FLT) to be challenged for the next couple of years.  We would expect little or no income from these stocks for at least three years.

Banks

Financial institutions are regulated by the Australian Prudential Regulation Authority (APRA), which provided those institutions with a directive on 7 April, 2020 “to limit discretionary capital distributions in the months ahead” including “prudent reductions in dividends” and “seriously consider deferring decisions on the appropriate level of dividends until the outlook is clearer”.  

On 29 July, APRA softened its directive, suggesting financial institutions should limit dividends to no more than 50% of earnings.  This is substantially below recent payout levels of 70-90%.

In response to the April APRA directive, ANZ (ASX:ANZ), Bank of Queensland (ASX:BOQ) and Westpac (ASX:WBC) deferred their interim dividend decisions, whilst National Australia Bank (ASX:NAB) cut its dividend by 64% and Macquarie Group (ASX:MQG) by 50% (and that being paid from non-bank areas of its business), with Westpac subsequently cancelling its dividend altogether.  

Disappointingly thus far, no banks have used underwritten dividend reinvestment plans. We have argued that this would have allowed banks to avoid significant dividend cuts while still maintaining capital ratios required by APRA, and was actually authorised in the April APRA directive.

The Commonwealth Bank (ASX:CBA) paid out 50% of its earnings as a final dividend following the APRA July announcement, but this meant CBA’s 98¢ 2020 final dividend was substantially lower than last year’s $2.31 final, as its APRA mandated lower payout was struck on lower earnings.  

ANZ also finally announced its interim dividend (reduced to 25¢) but Westpac, Bank of Queensland, and Bendigo and Adelaide bank (ASX:BEN) continued to defer their dividends.  

In the immediate future, we think all bank dividends will be challenged by both the APRA payout restriction and lower COVID induced earnings due to increased bad debt charges.  

However, should the economic impact of COVID prove less than expected, banks may be in the fortuitous situation of being able to write back bad debt charges if those bad debts don’t eventuate.  

Consumer sector

Dividend expectations have also been hit for many consumer discretionary stocks and AREITs, but here one needs to be careful in discriminating between stocks. 

Retail sales took a big hit in April, following the somewhat surprising panic buying inspired rise (mainly from consumer staples not discretionary) in March. This prompted stocks such as Harvey Norman (ASX:HVN) and Super Retail Group (ASX:SUL) to cancel their already declared dividends, while jewellery and fashion accessories chain Lovisa Holdings (ASX:LOV) deferred its dividend payment.   

Retail sales statistics show sales of clothing, shoes and restaurant and café trading are still well below normal levels, but many other areas are doing very well, with total retail sales now back above last year’s levels.  

Strong reported domestic sales numbers from JB Hi-Fi (ASX:JBH), Harvey Norman and Wesfarmers (Bunnings, Kmart and Officeworks) (ASX:WES) support the retail data and augur well for future dividends.  Interestingly, Harvey Norman announced that it will now pay a dividend, albeit reduced. 

AREITs

Within AREITs, the outlook is mixed.  We believe industrial property trusts (logistics and data centres) have a strong outlook as they are benefiting from the acceleration of e-commerce and digitalisation sparked by COVID-19. Goodman Group (ASX:GMG) and Charter Hall Group (ASX:CHC) have both reaffirmed guidance. 

The outlook for retail trusts is not so good. Landlords are facing the likelihood of significant rental declines, bad debts from struggling tenants and the potential for higher vacancy rates as the retail industry rationalises.  

Importantly, it must be remembered that in this environment dividend traps are likely to be prevalent. Take Scentre Group (ASX:SCG) as an example – it was trading on an historical yield of 10% before it announced it won’t be paying an August distribution. Be wary of high historical yields.

Bright spots

Consumer staples should continue to do well despite COVID-19, but we also like the prospects of some surprising sectors and Plato, by rotating into these sectors, aims to continue to deliver superior income and capital growth for clients. 

For some time now, we have held an extremely positive outlook on Australia’s iron ore miners, and iron ore prices have continued to hold up well through the pandemic. The world, particularly China, will need to spend big on infrastructure to recover from this pandemic-induced recession and infrastructure generally requires steel made from iron ore.  

We expect strong dividends from the likes of Fortescue (ASX:FMG), Rio Tinto (ASX:RIO) and BHP (ASX:BHP) and they are trading on handsome yields. Fortescue, in our view, was one of the standouts of the August reporting season, massively increasing its final dividend.  

Another positive area is Australia’s gold miners. On the back of global economic concerns and the immense amount of money printing being undertaken by the US Federal Reserve, the gold price has moved from around $1800 an ounce a year ago to around $2700. 

Although dividend yields on gold stocks such as Regis Resources (ASX:RRL), Northern Star (ASX:NST) and Evolution Mining (ASX:EVN) are relatively low, we believe they have a solid outlook.

The other big unknown at the time of writing is the US election. We’ve had many clients ask for our views on this. Our response – while there may be some short-term market volatility, we don’t anticipate any significant impact on our income strategies. 

A final note - there remains significant economic uncertainty and we are yet to see the full impacts of the economic shutdown. Investors should always seek professional advice.