Competing for cash: why are companies cutting their dividends?

Martin Cholwill, Senior Fund manager

14 September 2016

Many actions have unintended consequences, and ultra-low yields are no exception. For companies with defined benefit pension schemes, liabilities have soared as a direct result of the sharp decrease in UK government bond yields, thereby widening the gap between the sums to be paid out and the value of assets available to fund these payments. As a consequence, a number of firms have hit the headlines with their decisions to divert cash away from dividends, and instead to use it to decrease their pension deficits.

No discussion of dividend prospects would be complete without talking about pension deficits and their potential impact on the ability of UK companies to pay dividends going forward. Pension fund deficits have always been an important consideration when assessing both a company’s valuation and its capacity to pay dividends; since the credit crunch of 2008 and the onset of record-low government bond yields, this issue has become even more pressing.

Defined benefit pension schemes are a liability on a company’s balance sheet, the same as any other debt owed, and should be viewed as such when analysing the potential for sustainable dividend payments. The pension deficit should be included in the enterprise value calculation, and regular payments towards reducing this deficit should be accounted for when looking at the company’s free cashflow, which is the source from which dividend payments will be made.

Clearly, a company that struggles to generate free cash, that is highly levered and that has a significant pension deficit will struggle to pay dividends.

Please click here to read full article.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.