In this article, Mike Kerley, Asian equity income portfolio manager, shares his views on whether Asian companies will follow the recently announced dividend cuts in the US, UK and Europe, the reasons for taking a positive view on dividend sustainability in Asia, as well as portfolio positioning amid the coronavirus uncertainty.
- Asian banks are generally well capitalised and have low dividend payout ratios, and in many cases are state owned where the governments rely on dividend income to bolster revenue. This suggests that Asia is less likely to experience the same level of dividend cuts seen in the US, UK and Europe.
- Asian companies seem relatively well positioned to pay dividends this year. The coronavirus impact has not been as severe as in some western countries; in China and South Korea lockdown measures are now being loosened and the economic momentum appears to be positive. Many Asian companies have large levels of cash on their balance sheets, while the dividend payout ratio has room to grow as the region remains far below its western peers.
March was a dreadful month for all equity markets, with wild swings in virtually all sectors, however Asia and especially China fared better than most. While the coronavirus looks to have peaked in China, South Korea, Taiwan and Hong Kong, cases are still rising in South Asia, with India, Pakistan and Indonesia the most immediate concerns.
For Asia, given that supply issues have largely been addressed, the biggest concerns now revolve around demand, specifically demand for the region’s exports. China is returning to work – official figures suggest around 85% of workers are back^, with the focus more on manufacturing and essential services. Restrictions on movement in China have been relaxed but have not been removed. In terms of government action, interest rate cuts have been announced across most countries as well as fiscal stimulus, and at the time of writing we still await details on the magnitude of fiscal support that China will provide.
How sustainable are dividends in general?
The recent cutting and cancellation of dividends by banks and other companies in the US, UK and Europe has focused investors’ minds on where dividends are at risk. In terms of the banks we have believed for some time that the sector was more exposed in this downturn, firstly from lower profitability from falling interest rates but also the potential of having to perform ‘national service’ (a directive by the government to act on its behalf) through credit extensions that were not necessarily in the best interests of the banks or shareholders. Within Asia Pacific however, there is less need for these measures to be applied although if they are, Australia and Singapore could be the most likely candidates. Generally, Asian banks are well capitalised and importantly, have lower dividend payout ratios than some western peers.* In many cases they are state owned and the governments rely on dividend income to bolster revenue. As an example, banks in China are over 50% owned by the Ministry of Finance and have payout ratios of only around 30%, compared to around 40% for banks globally*.
Outside the banking sector we are assessing where we think dividends could be at risk. Overall, we are confident in the ability of the companies in our portfolios to pay dividends, even factoring in worst case scenarios on revenues and cash flow, as most sit with net cash balance sheets and low dividend payout ratios. The areas which are more difficult to predict are government measures that could impact profitability and potentially dividends such as if a form of corporate ‘national service’ is called upon to ease the burden on manufacturing or other areas affected by the lockdowns. For example, in Singapore real estate investment trusts (REITS) are being impacted by government measures that have been introduced to provide a rent holiday for tenants impacted by the coronavirus. This will mainly impact retail mall operators, where we have limited holdings in our portfolios, but even so it will constrain dividend growth for the sector going forward.
Our focus remains on aiming to provide sustainable yield by investing in domestically-orientated businesses. In line with this objective and in response to recent events we have made the following portfolio changes:
- Reduced banks across the board – we think banks’ profitability will suffer if interest rates fall further and stay low, while ‘national service’ to extend or increase credit lines could have a detrimental impact on the quality of loan books and lead to higher provisions/write-offs over time.
- Increased holdings to beneficiaries of lower interest rates. We think property, in particular real estate investment trust (REITS) can offer attractive returns compared to cash and bonds.
- Increased high yielding stocks – such as telecoms and infrastructure REITS. The world still has an ageing population and with interest rates at record lows the demand for yield is likely to prevail.
- Increased holdings in China – we think China is best positioned to emerge from the virus and have taken advantage of price weakness to add to attractive names.
Reasons for the positive view on Asian dividends
We are confident of the Asian region’s ability to pay dividends in 2020 owing to the large levels of cash on many companies’ balance sheets and most importantly the lower levels of dividend payout compared to the West. Asia Pacific ex Japan has a dividend payout ratio of only around 35%*, far lower than many western countries. Earnings undoubtedly will come under pressure but we believe that the large gap between earnings per share and dividend per share is likely to ensure dividends are more sustainable in Asia than other regions.
Another supporting factor for Asian dividend sustainability this year is the fact that in countries such as China, Hong Kong and Taiwan, dividends are only paid once a year with some lag. Currently, these markets are reporting financial year 2019 earnings and dividends based on last year’s numbers, which was generally a decent year in terms of profitability, and before the coronavirus emerged. We have seen companies paying increased dividends both in line with earnings growth, and some have raised dividend payout ratios. Dividend surprises have come from diverse industries such as property, power supply, consumer and technology. A large proportion of our portfolio holdings are in these areas, which underpins the reason for our optimism on yield sustainability this year.
In our view, Asia looks better positioned to continue to pay dividends than many other regions. The coronavirus impact has not been as severe as in some western countries and in the case of China and South Korea, lockdown measures are now being loosened and the economic momentum appears to be positive. With the pressure on dividends in some key sectors in the UK and Europe, and the shadow hanging over the high yield credit market, Asia could stand out as a relative beacon of stability for the income investor who is struggling to find alternatives in this environment of record low interest rates.
^Source: CNBC, For some Chinese businesses, there’s no going back to life before the coronavirus, 2 April 2020.
*Source: Jefferies, Factset, Bloomberg. Dividend payouts- banks and region wide as at 31 March 2020. Past performance is not a guide to future performance.