In a climate of negative interest rates, dividends have been invaluable for European investors looking for inflation-adjusted income.
But one of the many effects of the covid-19 outbreak has been a bonfire of dividend payments for European companies.
How bad is it likely to get for equity income investors in Europe?
With little or no revenue, many European companies have simply not had the capacity to make payouts, particularly in hard hit sectors such as travel and leisure.
Even where companies have been able to continue generating revenues, many have sought to conserve cash to see them through uncertain times.
Policymakers have also played a role in companies cutting dividends: European governments have clamped down on dividends where companies have taken state aid, or furloughed staff.
Early estimates were for falls of around two-fifths for European dividends.
A note from Barclays in April suggested dividend paid by companies listed on the pan-European STOXX 600 index would take a 40% hit, in line with the fall in earnings per share.
Market expectations are currently suggesting that dividends will fall by around a third.
Charles Glasse, lead manager of the Waverton European Dividend Growth Fund, says: “The covid pandemic has been every income fund manager’s worst nightmare.
“Cash preservation, no matter how sound the balance sheet, has been the order of the day.
“In addition, many sound companies received furlough money, which often (particularly in France) prevented them from paying dividends.
“Finally, the few that were happy to pay still needed an AGM to ratify/set the level. Covid prevented these meetings from taking place. Happily, new regulations and workarounds allowed virtual AGMs.”
Among the first dividend casualties were financials, where regulators immediately stepped in encourage banks and insurance companies to halt payments to shareholders.
The worst sectors for cuts have been largely predictable: travel, oils, retail, and industrials, but there have also been some surprises: telcos, for example, and even some food companies.
In contrast, safe havens tended to be sectors such as utilities, consumer staples, IT and healthcare.
Will it rebound from here?
There appears to be no immediate prospect of a revival in financials.
In late July, the European Central Bank called on lenders to continue with the freeze on dividend payments until at least January.
Investors have expressed frustration that there appears to be no clear guidance as to the conditions for dividend payouts to resume.
Oils, retail, travel, and financials, however, also look likely to struggle in the medium terms.
Elsewhere the picture is marginally more encouraging.
Glasse says that a number of large companies that initially delayed payments are now restoring them, with second quarter earnings not as bad as feared: “Our largest holding, Deutsche Post, intends to pay the full annual dividend in September that was passed in May and we expect to see more coming back soon.”
Once pressure abates
George Cooke, manager of Montanaro European Income, says: “We do expect some of our companies to pay special dividends in later years, therefore ‘making up’ for cuts it in future[…].
“What we’re focusing on primarily is the ability for dividends to bounce back once political pressures abate and to see sustained growth going forward.
“For that a company needs a strong balance sheet, good mid to long term structural growth prospects and if we can combine that with market leading positions where some of the competitors may be weakened, so much the better.”
So far, active managers appear to have been able to navigate the dividend cuts relatively effectively.
Waverton, for example, says that minimal exposure to financials, travel, and retail has meant that while dividend flows have taken an ‘eyewatering’ hit, it is still less that the wider market.
Sam Morse, portfolio manager of the Fidelity European Fund and Fidelity European Values PLC, says that 60% of his holdings expected to grow their dividend payments this year and only around 20% expected to cut by more than 25%.
He adds: “Our strategy is to continue to treat each company held on a case-by-case basis (paying a lot of attention to valuation), while staying cautious of those companies that are reducing dividends whatever the public explanation.”
Dividends will almost certainly be drawn from a narrower range of companies in a smaller range of sectors in the future.
There will be sectors that will be slow to bounce back, either because of continued government pressure (such as the banks) or because they don’t have the revenues to sustain payouts to shareholders.
It is not all gloomy for European equity income investors, but the market may look different from here.