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Killing sacred cows

Killing sacred cows
May 6, 2020
Killing sacred cows

After hundreds of similar dividend cancellations or resets this year – including a cut by Norway’s state oil giant Equinor – the move certainly fits the current trend. “Not a surprise” was the verdict of Aberdeen Standard investment director Charles Luke.

The market reaction suggested otherwise. In the hours after chief executive Ben van Beurden announced the measure, Shell’s London-listed stock dropped as much as 11 per cent. On learning that they now own a more resilient business, some shareholders nevertheless felt compelled to sell. More than simply a one-off corporate action, Shell’s dividend cut will have been felt deeply by investors who have come to view the payout as immutable.

On the same day as Shell’s announcement, pub chain JD Wetherspoon (JDW) confirmed it had raised £141m from institutional investors and directors in a fittingly  discounted 900p a share placing. Again, the move looks eminently sensible. Prior to the fundraising, the company had already furloughed staff, deferred rents and capital expenditure, drawn down its credit facility, and cut overheads, dividends and executive pay – moves that management suggested would have given the business enough liquidity to keep it afloat until the end of November, should its pubs remain closed until then.

When its doors eventually reopen, Wetherspoons’ “principal assumption” is that initial like-for-like sales will drop 10 per cent, before recovering above pre-crisis levels within seven months. But in a tacit admission that it is beholden to both government rules and unpredictable drinker sentiment, the group presented the share placing as a backstop, “to deal with very low sales after reopening, helping the company to return to growth as the market normalises”.

An alternative reading is that two well-established pillars of the investment case – an unrivalled ability to self-fund and a precise understanding of customer behaviour – have simply vanished. The primacy of outspoken chairman Tim Martin has also taken a knock, after he agreed for his shareholding to drop to below 30 per cent – a prospect which analysts at Canaccord Genuity described as “unthinkable” just two weeks before it became reality. Past norms have proven illusory.

In both cases, a needs-must approach has shattered what were until very recently held as safe assumptions. Shifts can occur suddenly. At the end of March, the City's largest banks caved in en masse to the Prudential Regulation Authority’s request to stop dividends and variable remuneration. Ten years ago, even after massive bailouts, humbling capital injections and near collapse, these same lenders stubbornly protected bonuses. “I think that’s a sign that if even the bankers realise things have changed, then maybe they really have,” the economist and former UK Treasury adviser Diane Coyle recently remarked.

The corporate and economic damage wrought by the Covid-19 health crisis is a brutal reminder that there are no sacred cows in investing. Past commitments to shareholders, however bullish or forcefully made, are never iron-clad. Equally, fundamental beliefs about the way markets function only exist to be tested. The negative WTI prices that came just a week before Shell’s cut was one sign of this; the trillions of dollars-worth of negative-yielding bonds that have proliferated since 2014 are another bizarre emblem that pre-date the present crisis.

Commentators are equally guilty of resting on their laurels. In March, this writer said that Shell’s balance sheet and bank support would be enough to maintain shareholder distributions, and that they looked “to be safe for this year”.

For investors, a safer course of action might be to add humility to their portfolios, and accept the notion that companies, institutions and systems only behave in predictable ways until they don’t – or can't. Right now, that means wrestling with two sacred cows: protecting society from a deadly disease, and keeping the economic system's lights on. Without the latter, “there is no future”, as Ford (US:F) president and chief executive Jim Hackett put it on last week’s first-quarter results call.

“Turning the economy back on challenges the question of whether it is safe enough,” he added. In the battle between two competing absolutes, both are likely to be compromised. That will mean plenty more pain for us all, investors included.