Central banks are constantly modelling theoretical economic threats, but even though the outlook on interest rates has become decidedly less hawkish over the past six months, the fact remains that many companies continue to return capital to shareholders despite no commensurate increase in earnings and/or cash flows.
If you look at distributions from some former public utilities, the so-called bond proxies, it’s clear that they are being funded by asset sales, or through increased borrowings rather than cash flows. It’s by no means a uniform practice, but widespread enough to create havoc if interest rates start rising at some point.
UK stocks now yield 4.75 per cent, which is 36 per cent ahead of the 30-year average. And yet cover ratios for four of the leading five payers in Q119 – Royal Dutch Shell (RDSB), BHP (BHP), AstraZeneca (AZN) and Vodafone (VOD) – are down on their five-year average. The outlier here is BP (BP.), although that’s a reflection of the gradual fall-away in restitution costs in relation to the Deepwater Horizon disaster.
Broadly speaking, all these FTSE 100 constituents have been able to fund their dividend payments through free cash flow, but some are sailing closer to the wind than others. The overall view on cash flows can be opaque given the impact of capex commitments, specifically their front-loading and delay through to commercialisation. AstraZeneca provides a case in point. The group’s net debt peaked at around $16.3bn (£13bn), or 135 per cent of shareholders’ funds, in the first quarter of this year as it boosted investment in its drug pipeline to counter the negative impact of patents expiring. The group also raised $3.5bn via a share placing earlier this year, ostensibly as part of a new research collaboration with Japanese drug company Daiichi Sankyo. But the capital raise was completed just days after AstraZeneca had forked out another $2.43bn to shareholders as part of its "progressive dividend policy".
This largesse seemed curious given the timing, prompting analysts at Hardman & Co to question whether “earlier cessation of share buybacks and re-basing its dividend, would have left [AstraZeneca] in a much stronger position”. The conjecture points to another drain on cash flows; the $29.4bn spent on share buybacks through 1999-2013.
AstraZeneca isn’t alone. S&P 500 constituents have more than doubled the amount they’ve committed to buyback programmes since 2012, hitting a record $806bn in 2018, while Shell – the world’s biggest dividend payer – recently committed to handing out $125bn in dividends and share buybacks through 2021-25.
At the turn of the millennium, chances are that if you quizzed an investor about what the main determinant was in total returns for most Asian stocks, the answer would come back as capital appreciation – and they would have been on the money. But companies in Asia have gradually placed more emphasis on capital distribution and payout ratios, not only as a means of attracting a larger pool of global investors, but latterly to provide an attractive alternative to traditional income asset classes.
Around two-thirds of total returns generated by the MSCI Asia Pacific (ex-Japan) index have been derived from income distribution over the period, while figures published by Henderson Far East Income (HFEL) show that regional dividends have risen by 220 per cent since 2009, well in advance of growth rates across western markets. It’s worth remembering that dividend returns in Asian stocks are strongly correlated to GDP growth.
