The coronavirus pandemic could shape how UK businesses think about dividends going forward, says Franklin Templeton UK Equity’s Colin Morton. He shares his on-the-ground thoughts on the UK economy, and how it measures up against the last global economic shock.
As investors continue to navigate through the unprecedented global health crisis we have experienced this year, we’ve seen governments and central banks worldwide deliver extraordinary policy responses. These include large reductions in interest rates and substantial quantitative easing (QE) programmes, which have supported the bond market.
In the short term, we are currently considering what the exit strategies for these policies are—we’ve seen a few encouraging signs from the easing of lockdowns across some European economies. The United Kingdom is a few weeks behind other European economies in terms of a phased-in economic re-opening. For example, non-essential shops re-opened on 15 June after a three-month closure. The concern is whether we’ll see a resurgence in infection rates as people start going back to some level of normal activity.
An Unparalleled Global Economic Shock
Concerns hang over the foundation of some of these government or central bank policy responses. For example, the United Kingdom enacted a job retention scheme, which allows employers to furlough workers on 80% of their salary. The furlough scheme has undoubtedly protected a large amount of jobs in the country.
Many think tanks estimate that one in three people in the United Kingdom are currently furloughed. Questions remain what will happen when companies have to start funding payroll themselves after the furlough scheme winds down between August and October of this year. It may be that the UK government will have only temporarily saved the jobs companies were planning to let go.
The charts below show the course—and the speed—of unemployment claims in both the United States and the United Kingdom. Some investors might be numb to the word “unprecedented” at the moment, yet COVID-19 truly is an unparalleled global economic shock. We’ll be watching events in the United States closely as the economy gradually opens up.
Another aspect we’re monitoring closely in the United Kingdom is public sector borrowing. Over the last 10 years following the global financial crisis, annual net borrowing (i.e. budget deficit) to gross domestic product (GDP) ratio was reduced to about 2% of the economy. Given the UK policy response leading to more government borrowing and a potentially shrinking economy, we think the United Kingdom could reach as much as 15% net borrowing to GDP in 2020, clearly a huge increase as seen in the second chart below.
What’s counterintuitive is that we have a situation where government finances are in a worse situation than they were three months ago, yet they can borrow money at a cheaper rate, since those that are buying bonds are driving bond prices down. Despite the current financial situation, the UK government is able to take advantage of very low interest rates.
Three Potential Scenarios Face UK-Listed Companies
As we previously discussed in March, just when some companies were starting to forego dividend payments, we recognised some UK-listed companies, particularly those in consumer-facing sectors, have had to adjust their dividend policies in the wake of the pandemic.
While it’s hard to predict how long this crisis will continue to weigh on company balance sheets and dividends, it is becoming clearer that dividend policies are still up in the air for many UK-listed companies.
Against this backdrop, companies have split into three camps: those that have suspended, cut or cancelled dividends.
There are companies that have so far delayed dividend payments—they haven’t cancelled them, and they haven’t cut them. Some companies in industries where the virus generally hasn’t impacted as badly are hoping the outlook will improve over the next three to six months. And if they do, there’s a chance that they will pay the dividend that they’ve delayed. So, we may see some element of catch-up.
Meanwhile, other companies have completely cancelled dividend payments, and generally speaking, the pandemic has had a negative impact on companies dependent on consumers. It would be extremely difficult for them to pay dividends at this point in time. Companies that do not have much (if any) revenue at the moment, and have taken advantage of government schemes and cancelled dividends, probably won’t be paying them at all this year.
The Future for Dividends
Ultimately, we don’t think the pandemic will fundamentally break the concept of a steadily rising and consistent dividend story in the United Kingdom. What will likely happen is a refreshed approach—it will make businesses think differently about how they pay dividends.
Some people have argued in the past that companies with a model wherein earnings are very dependent on elements that are out of investors’ control i.e., oil prices, should have more of a payout ratio system rather than an absolute level of dividend. We’ve seen a gradual move towards this system from some oil businesses, for example, in the last three or four years. Some will pay between 40%-60% of their earnings out as a dividend, rather than committing to a progressive dividend policy.
For businesses where there might be a lot more cyclicality to their earnings, which is a lot more difficult to predict, perhaps we will see a similar type of dividend policy.
It largely depends whether businesses think a shock like we have seen with COVID-19 is something that could happen again or even regularly, which could encourage companies to run their businesses with stronger balance sheets going forward. Furthermore, companies which are more cyclical and consumer-dependent might want to make sure they have a stronger balance sheet and pay out less in terms of special dividends and curtail share buybacks going forward.
In a normal type of economic scenario, however, we think many companies with quality businesses and good long-term prospects should be able to keep growing their dividends, albeit from a lower base.
Franklin Templeton Key risks & Disclaimers:
Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as of publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.
Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Issued in the U.S. by Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com—Franklin Templeton Distributors, Inc. is the principal distributor of Franklin Templeton’s U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.
CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.
What are the risks?
All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. For stocks paying dividends, dividends are not guaranteed, and can increase, decrease or be totally eliminated without notice. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.
This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.
The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.
If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.