Fallout from the COVID-19 pandemic has changed the landscape for dividend-oriented investors. As shown in Figure 1, dividend reductions and suspensions have risen sharply and are on a pace to exceed the levels of the 2008-2009 financial crisis. Looking at the data closer, Figure 2 shows us that of the companies reducing or suspending their dividends, the share of companies suspending payouts completely has risen dramatically, to approximately 65%. This compares to 29% during the financial crisis. Overall, analysts expect dividend payouts to fall 10%-30% this year, with the largest cuts coming from the energy and consumer discretionary sectors.
Data from 1/1/2000 to 4/30/2020. Source: FactSet, Morgan Stanley.
Source: FactSet, Morgan Stanley.
Energy. With crude prices below breakeven levels in the wake of a massive contraction in demand and excessive oil inventories, the energy sector is struggling. As expected, many oil companies have reduced or suspended dividend payouts.
Examples include Royal Dutch, a high-quality integrated oil company, that reduced its dividend by 66%. Similarly, oil services company Schlumberger slashed its dividend by 75% and is restructuring its business, cutting jobs and closing facilities to cope with persistently low prices.
Financials. We believe deteriorating credit quality will lead banks to reduce dividends. However, our analysis indicates select trust banks and insurance companies are good dividend prospects. We believe PNC Financial Services Group is a good example, with its record of consistent dividend payments for more than 10 years.
Consumer Discretionary. Dividend reductions and suspensions are likely to persist in the consumer discretionary sector. The pressure on brick-and-mortar retailers only worsened with stay-at-home orders. Many consumers aren’t feeling as confident or happy to spend, harming sales of big-ticket items.
Harley Davidson, for example, makes high-end motorcycles and its sales plummeted as consumers stopped buying luxury goods. Harley has reduced its dividend, delayed product launches and temporarily reduced salaries as poor market conditions remain a headwind for the foreseeable future.
Real Estate Investment Trusts (REITs). Even though REITs are designed to provide income streams to investors, many are reducing or suspending their dividends. Weyerhaeuser is an example. The timber REIT suspended payouts even though our analysis indicates it has cash to cover dividend and debt payments through 2021. This suspension may indicate that management foresees significant headwinds for the business. Notably, the company did not reduce or suspend dividends during the financial crisis.
Health Care. The health care sector has been a top performer despite the pandemic. However, there has been a distinct divergence between companies tied to elective procedures versus those providing nonelective health care services. For example, while many patients could opt to delay knee replacements, discontinuing prescription medications isn’t generally an option. As a result, postponed medical procedures have decimated the earnings of medical device companies such as Medtronic, and large pharmaceutical companies such as Pfizer haven’t experienced disruptions in their revenues.
Diversified health care company Johnson & Johnson has fared well, increasing its dividend payment despite the challenging environment. J&J enjoys varied revenue streams, a best-in-class balance sheet and leading market positions in pharmaceuticals and biotechnology, medical devices and consumer health care. We believe the company can sustain and grow payouts throughout various economic environments.
Information technology. Tech stocks held up remarkably well during March’s sell-off and have risen in line with the broader market during the subsequent rebound. Balance sheets in the sector appear solid. Many technology companies have large cash balances and relatively low debt.
Even though the sector is known for its high growth potential, we tend to favor the older, more stable tech companies that we believe are more likely to maintain or increase their dividends. For example, growing demand for its productivity and cloud computing offerings supports Microsoft’s dividend. Elsewhere in the sector, the downturn spurred sales of semiconductors manufactured by higher-quality companies like Texas Instruments and Applied Materials.
Consumer staples. Companies in this sector have historically posted solid, but not spectacular, numbers in rapidly rising markets while offering defensive characteristics during volatile periods. Key players in the sector include Procter & Gamble and Kimberly-Clark, both of which have earned the moniker “dividend aristocrats” for consistently raising dividends for at least the past 25 years. P&G and Kimberly-Clark have raised dividends and been sources of stability through this volatile stretch.
Despite the spate of dividend cuts and suspensions during this COVID-19-induced recession, we believe opportunities remain for dividend-oriented investors. We consider the long-term performance of dividend payers to be encouraging. During the 20 years ended March 31, 2020, the highest-yielding companies in the Russell 1000® Index posted a 9.4% annual return compared to 4.9% for the broad index.
Of course, there’s more to it than simply buying dividend payers. We’re digging deeper in search of businesses that offer high, stable and sustainable returns on capital, solid free cash flow and clean balance sheets. We believe the financial productivity of companies with these characteristics will help them withstand this economic downturn and grow their businesses and dividends in the future.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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