Income Investments Under Pressure
- 01 April 2020
- 10 mins reading time
Income-generating investments are under intense pressure. These are investments where the aim is focused on delivering regular payments to their holders, rather than focusing on growing in value.
The measures being taken to slow the spread of Covid-19 and the international oil price spat are making it difficult for the majority of global companies to turn a profit at the moment.
What’s more, interest rates are at all-time lows, with the consequence that income generated from newly issued bonds is very low.
While these factors will take its toll on returns in 2020, the companies that take the unpopular steps of holding cash rather than distributing it to shareholders are more likely to survive and prosper in the post-pandemic world. The lesson for investors is to be patient.
The authorities are insisting
The Prudential Regulation Authority in the UK has instructed all the biggest UK banks to suspend dividend payments that were due from last year, as well as any for 2020. This is to help them retain cash to sustain their respective operations while providing as much support as possible to businesses and individuals.
The banks have complied. These include Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland, Santander and Standard Chartered.
According to a recent report , this instruction has prevented around £7.5 billion-worth of dividend payments being paid-out. The report adds that those banks accounted for around 17% of the dividends paid out by FTSE 100 companies last year. The significance of this is that the instruction to just six companies has taken a disproportionate chunk of dividend payments off the table.
A more stringent requirement has been implemented across the eurozone. The European Central Bank (equivalent to the Bank of England) has ordered banks to suspend both dividend payments and share buyback programmes. A share buyback pushes share prices higher, effectively providing a return on investment to holders of the relevant shares.
We think it probable that the Bank of England and other central banks will adopt a similar approach over the coming days.
Other companies set to follow
It’s not just banks that are having to be more prudent with their cash. At least 100 UK companies have scrapped dividend payments or share buybacks in 2020 including Britvic, National Express, Next, Kingfisher, ITV, Stagecoach, Go-Ahead and Pearson. This accounts for more than £4.0 billion of dividend payments .
That chances are that this number will rise sharply.
Firstly, companies are setting aside as much cash as they can to weather the financial storm.
Secondly, companies reliant on the oil industry are struggling with the low price of oil. The oil producers’ costs stay much the same regardless of how much they can sell oil for. The prevailing price of oil is insufficient to cover the costs of most oil companies. And if their revenues are down, they spend less with all the engineering, research, logistics, catering, transport and other companies that depend on their custom.
There is a third, political factor. Few companies would be looked upon favourably if they were to pay dividends to shareholders while they or other companies are turning to the government for hand-outs.
The pressure to be prudent is immense, and appropriately so.
Low interest rates
The problem for income-generating investments extends beyond company shares. With interest rates at historically low levels, bonds that are being issued now offer tiny yields.
For example, at the time of writing, the government’s 10-year Gilt is paying a yield of around 0.30%. If we turn the clock back 10 years, the yield was almost 3.9%. In other words, the yield on this low-risk rated government bond has fallen to a thirteenth of what it was a decade ago.
At the same time, the ability of higher-risk rated governments and companies to maintain bond and interest repayments is under pressure. If they are generating lower tax revenues or profits, they have less money to maintain debt obligations.
The insistence that companies retain cash rather than paying dividends to shareholders or buying back stocks is a good thing in this context. By holding more cash, companies are more likely to be able to meet their debt commitments. That, in turn, can help to reduce the risk of companies defaulting on their debt obligations.
With all of these factors in mind, it seems inevitable to us that income-generating investments are going to suffer in the coming months.
However, we commend the prudent behaviour of companies that are looking to the long-term by developing a cash resource that will make it more likely for them to survive this difficult period.
A dividend payment is always nice, but not when it’s the last one that the company will be around to provide.
Any views expressed are our in-house views as at the time of publishing.
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