Miners usurp banks as biggest dividend payers.

As record low interest rates ensure near zero returns on bank term deposits, the appetite for other sources of income has never been greater. And with consensus expectations that the official cash rate will not rise for several years, the hunt for yield shows no signs of abating. 

In this environment, company dividends are an obvious focus for Australian investors.   

COVID impacts 

As the coronavirus spread globally and the economic and health crisis accelerated, Australian companies were suddenly confronted with a highly uncertain outlook. Credit markets froze, the sharemarket went into free-fall and almost overnight, many businesses found themselves with drastically lower revenue. 

In response to the rapidly changing and potentially disastrous trading conditions, many companies cancelled, cut (often substantially) or postponed their dividends to shareholders. A small cohort of companies were able to maintain their dividends at previous levels by increasing their payout ratios. 

As many Australian investors would be well-aware, dividends from the banks fell particularly sharply. Dividends of the three banks that reported following the onset of the COVID crisis, were collectively down -90% on the prior period.

(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).

Winners and losers

Early in the pandemic when market volatility was at its height and the economy was facing massive supply and demand shocks simultaneously, the outlook for Australian companies and their capital positions was almost universally dour. 

However, as time passed, clear winners and losers have emerged, with implications for company dividends. 

Although there are nuanced impacts within industry groups and on individual companies, in general companies that sell goods have benefited as fiscal measures (such as JobKeeper and JobSeeker) have bolstered household cashflows and disposable income. 

In contrast, companies providing services have suffered due to COVID restrictions including lockdowns and travel bans. Here is an overview of COVID’s effect on sector dividends.

Miners

Australia’s miners have usurped the banks’ position as the biggest dividend payers in the market. The highest iron ore prices (in Australian dollar terms) have seen a surge in revenues for these companies, particularly those exposed to iron ore, leading to strong profits and dividends to shareholders. This trend has seen many investors shift from the big retail banks to miners in their hunt for yield. 

Unlike the banks which have traditionally provided fairly consistent returns, dividends from the miners can be expected to fluctuate due to the highly cyclical nature of their businesses. 

While the iron ore price remains at historical highs, the miners are likely to provide a compelling income opportunity however, these companies cannot be expected to pay consistently high dividends over time.    

Retail

Retailers of both consumer staples and discretionary items have performed strongly in the COVID climate. The excess cash in the economy from government stimulus is providing the sector with a significant tailwind, particularly businesses providing household items, such as furniture and hardware. 

Retailers with a strong online presence have done especially well as customer access to ‘bricks and mortar’ stores has been restricted by physical distancing measures. It is hoped that the initiatives announced in the Budget (including bringing forward individual tax cuts) and an improving economy will support the outlook for discretionary spending. 

However, government income support will fade materially into the next calendar year which may put downward pressure on the sector’s revenue and distributions to shareholders. 

Healthcare

For obvious reasons, over the course of the COVID crisis, healthcare companies have generally continued to perform well. These are typically more mature businesses with a propensity to return capital to shareholders and we expect these companies to continue to provide reliable dividends to shareholders in the immediate term. 

Australian Real Estate Investment Trusts (AREITs)

There has been a clear bifurcation of the listed property space because of the pandemic. On the one hand, industrial property trusts with distribution centres have benefitted from the surge in consumer spending and online shopping. In sharp contrast, retail property owners have seen their business models fundamentally undermined by lockdowns and other physical distancing measures. 

The future profitability of these companies is highly dependent on the course of the coronavirus, as well as the potentially permanent shift in customer preferences which favour online over in person shopping experiences. 

The outlook for office property owners is also obscured as employers and employees navigate the return to work, which may include a structural shift towards working from home, in turn reducing the need for office space.  

Banks

With broad exposure to the Australian economy, the outlook for dividends from the ‘Big Four’ retail banks is contingent on the resilience of businesses and consumers, as well as the housing market. 

The regulatory landscape will continue to be an important factor, with the APRA urging caution to bank boards regarding dividend payments and has recommended banks retain at least half their earnings. 

Although this guidance is not binding, we expect the banks will continue to adhere to the regulator’s view, which will put a cap on their distributions shareholders in the short to medium-term.

Reporting season 

The next major test for dividend trends will come in February 2021 when most Australian companies report their financial results. 

The propensity of a board to distribute capital will be largely determined by the certainty of the company’s outlook. If a business’ trading conditions remain tenuous in the New Year, we would expect its board to take a prudent approach to dividends, with a preference for conserving capital as a buffer rather than distributing it to shareholders.

Clearly, the outlook for most companies depends on the broader economic conditions. Currently, any lasting economic recovery is largely contingent on the trajectory of the global coronavirus pandemic. Increasing cases in Europe underscore the fragility of the recovery and the potential for ongoing uncertainty, particularly for businesses directly impacted by lockdowns and travel restrictions. 

Encouragingly, balance sheets are generally in good shape as companies have been able to readily access capital via equity markets and at favourable interest rates from banks. 

In our view, companies with a sound capital position will be well-positioned to distribute dividends to shareholders as conditions improve.