Liontrust Asset Management : Why income investors shouldn’t run from dividend cuts

It has been a brutal period for equity income investors, both through sharp share price falls and widespread dividend cuts in the wake of the Covid-19 crisis. Now the dust is beginning to settle, it is time to search for investment opportunities. Somewhat counterintuitively, we are finding some of the most attractive stocks, with the best long-term prospects, among the global leading businesses that cut dividends in Q2.

Under normal circumstances, a dividend cut is a signal that a company is uncompetitive in its end market and has weak long-term prospects. This time, however, many companies have simply been acting in a prudent manner, especially given the seismic and sudden impact of the crisis. They cut dividends so they could shore up balance sheets and maintain investment in their operations. Ranging from media to consumer skincare and machinery stocks like Disney, Estee Lauder and Rational, companies that have had dividend cuts and suffered reduced share prices are the types of investments we have sought out to drive the long-term returns of our Liontrust Global Dividend Fund.

Reeling from the closure of its theme parks in March, Disney cut its dividend in May (scrapping its semi-annual dividend). In line with a deteriorating outlook, the Disney stock price returned to levels not seen since 2014. However, the future economic prospects for the company is not its theme parks but its direct to consumer business like Disney+, Hulu and ESPN+. With Disney+ hitting 60 million subscribers within the first year (compared to Netflix, who took eight years to reach this number), the company is succeeding. Not to mention that Disney has a fortress balance sheet with $27 billion of cash on hand, and therefore we expect the company to return to dividend growth next year and provide investors with a steady stream of income for years to come.

Another example is Estee Lauder, which experienced weakened demand in early January from its key growth market in China. Even this company, which has prioritised its digital strategy for over a decade, suffered from the closure of its bricks and mortar stores, meaning it could not completely dampen the effect lockdown had on consumer demand.

Estee Lauder reacted quickly and cancelled its dividend in April, but we anticipate this to be short lived given the company's strong balance and ability to drive profitability from its e-commerce distribution channel. Whilst the lipstick effect is out in this downturn, skin care products like face masks, serums and moisture products are in, so this dividend cut will be short lived.

Lastly, Rational took a different route by cutting its annual dividend by 40% to reflect a drop in profitability rather than a cancellation. Rational is the industry leader in combi-ovens for professional kitchens, with a dominant market position and a payback period of only nine months on its products for new customers looking to automate their kitchens.

This owner-operator company has a more progressive dividend policy, which is to distribute 70% of earnings. This is a more effective mechanism for returning capital to shareholders because it does not anchor management teams to historical pay-outs but, instead, returns excess capital to shareholders after investing in the business. Rational is entering a more difficult operating period than most, but we believe the demand for hot food will return to previous levels (it is just that the distribution channel may change) and therefore the dividend cut will be short term in nature.

As we enter the next phase of the economic cycle, the most likely beneficiaries of this market environment are becoming expensive, but for income investors there is plenty of value to be found in untraditional places. We focus on total return, which means we can seek out companies that may not pay a dividend this year and have been unfairly punished and for which we have confidence they will return their dividend next year with strong prospects for consistent dividend growth into the future.

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, September 23, 2020, 10:23 AM