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“Stay-at-home” orders given by governors to slow the spread of COVID-19 have put more than 26 million Americans at least temporarily out of work and will reduce second-quarter gross domestic product by at least 30 percent on an annualized basis, according to the major Wall Street banks, making for the sharpest contraction since the end of World War II.
A slowing economy leads to lower corporate profits, causing companies to cut dividends as they hoard cash to bolster their balance sheets.
“S&P 500 companies’ forward earnings have already taken a significant hit and with more downward adjustment likely ahead, we expect dividends to rapidly feel the effects of this deterioration,” wrote Francois Trahan, head of U.S. equity strategy at UBS.
S&P 500 companies paid out a record $127 billion of dividends in the first quarter of 2020, according to S&P Dow Jones Indices, but a repeat performance isn't likely anytime soon. On April 9, six trading days into the new quarter, 50 companies, none of which were in the S&P 500, had already taken negative action on their dividend with 40 suspensions and 10 cuts, S&P data showed.
Just seven companies had taken positive action. The net reduction was $4.8 billion, S&P said.
With forward earnings projections set to drop sharply, the median S&P 500 dividend per share will fall 28 percent from $2.06 to $1.47, Trahan said.
Cyclical sectors, or those most sensitive to changes in the economy, like energy, materials and consumer discretionary, are at the highest risk of a cut. Oilfield service provider Schlumberger, miner Freeport-McMoRan and gaming operator Las Vegas Sands have already cut or suspended their payouts.
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Trahan warns “dividends will not likely prove a safe haven for companies in industries with significant downward adjustment to earnings.”
On the flip side, defensive sectors with more stable earnings like health care, communication services and consumer staples are at a lower risk. In fact, wholesaler Costco and consumer products maker Procter & Gamble have raised their dividends amid the economic downturn.
Steven Kron, director of U.S. equity research at Goldman Sachs, says the current environment offers companies the unique opportunity to implement a variable dividend, or one that “flexes with operating performance.”
The firm says 51 companies within the Russell 1000 have cut their dividends this year, a “last resort” for many corporate boards that often prefer to adjust stock-buyback programs, which don't occur on a regular schedule and are typically less visible.
Kron says that while there is a “social contract” between companies and dividend-seeking investors that could be disrupted, the “long-term benefits outweigh the near-term costs.”
A viable approach, one that some companies already use, is tying the dividend payment to its free cash flow, Kron wrote. Doing so would “better align cash distributions through a cycle and, in turn, create more durable balance sheets."