After a disappointing company reporting season, investment analysts are asking whether the dividends that companies have been paying out in recent years are sustainable. A report from Macquarie Securities suggests that they are not.
Overall earnings per share grew by around six per cent in the year to June, with non-resources companies increasing their earnings at only about half that rate. To maintain their dividends, companies increased their average dividend payout ratio (the proportion of profit that is paid to shareholders as dividends) from around 72 per cent in 2015/16 to around 76 per cent in 2016/17.
Back in 2011/12 the average dividend payout ratio was around 64 per cent. Growth in earnings per share has been much more modest over that period.
In a wrap-up of the reporting season, Macquarie says company boards are now asking whether they can keep doing this.
“The reporting season has finally laid bare a backdrop of outsized dividend growth in combination with anaemic earnings growth,” Macquarie says.
“Dividend growth has outstripped earnings growth, pushing the payout ratio higher for the past six years. The market has rewarded this trend but without the cover of falling interest rates and/or earnings growth, this is being questioned.”
Cash flows are under pressure. Growth in operating cash flow was just 1.4 per cent in 2016/17, while the growth in dividends paid was 2.9 per cent.
Despite the higher dividend payout ratio, there were some notable dividend cuts announced during the reporting season. Vocus Group, Crown Resorts, Origin Energy, Telstra, The Reject Shop, Star Entertainment Group and Harvey Norman were among the companies that cut their dividends.
There may be more next year. Macquarie is predicting that the dividend payout ratio will drop below 70 per cent in 2017/18.
And it says earnings forecasts for the 2017/18 year have weakened. Among non-resources companies average earnings estimates for 2017/18 fell by 2 percentage points from previous estimates to 4.3 per cent.
Of the 232 companies its analysts cover, there were 69 downgrades to 2017/18 forecasts versus 59 upgrades. The weak sectors include healthcare, insurance, media and telcos.
Factors influencing the downgrades include more intense competition from an increasingly selective consumer dollar leading to weaker revenue growth, higher energy costs, and defensive capital expenditure to defend positions.
Macquarie is sceptical about the idea that companies are reducing dividends so they can use more of their earnings for investment in growth. “There is rising excitement around a capex revival but we see limited evidence that this will provide the necessary bridge to support earnings in the near term,” it says.
“While this may prove conservative and we may be entering an upgrade cycle, our point is that expectations built into bottom-up forecasts remain relatively muted outside of the resources sector. Indeed, there is no broad increase in the ratio of capex to sales for the industrials universe.”
Macquarie is not the only group questioning the future of big dividend payouts. In its review of the reporting season, CommSec says “there is a re-assessment by companies about just blindly paying a dividend at all costs.”
CommSec says: “Telstra is in the process of adjusting payout ratios, ploughing more money back into the company than just issuing dividends. Scentre Group and Westfield are reconfiguring and redeveloping shopping centres to improve customer experience.”
It was not all bad news for investors looking for dividend growth. Among companies that upgraded their payouts were NIB Holdings, Treasury Wine Estate, Reckon, MYOB Group, Monadelphous Group, Bravura Solutions.
And resources companies made big payouts – Fortescue Metals Group, Evolution Mining and South32 among them.