I've considered a few titles for this article over the past few weeks, but I settled on the one it has now - just the right amount of reader appeal, I feel, and it represents accurately what I believe we as dividend investors can expect going forward.
Let's dive straight into what's happening.
What's happening with our dividends?
For many years, some dividend investors have espoused a philosophy where their stance might be, "I don't sell stocks unless they cut their dividend - in which case, I sell everything in the company."
(Photo Source: Meme Generator)
In the beginning of my rather short (until now) investment career during the advent of the last financial crisis, I considered long and hard whether this was a philosophy I wanted to include in my own investments. Mind you, back then I was a babe in the woods and hadn't yet formulated some of the most basic parts of my strategy. I also didn't have much capital. It would take until years later until I had what I now consider to be the fundamentals of my portfolio.
However, I believe the stance I just mentioned is so common that you've probably heard it quite often if you read dividend investors reports, blogs and articles from time to time.
As such, it will be interesting to see how these investors cope with the recent slew of news. Forget oil companies like Shell (RDS.B) or Occidental Petroleum (OXY), or stalwart real estate companies like Simon Property Group (SPG) which some claimed would never cut the dividend and have, or may very well do. We're talking about companies like the Walt Disney Corporation (DIS), which are, as of yesterday, not paying 1H20 dividend, effectively cutting their FY20 dividend in half with no idea what will happen in 2H20.
I know investors, in fact several, who hold Disney as 5-10% of their entire portfolio, given it's such a conservative stock, labeling themselves as dividend investors who live off their dividends alone.
Well, these people's incomes have just been subjected to a pretty harsh haircut.
In both my current work and my investments, I try to deal in absolutes, such as "I always do X if Y happens!" as little as possible. Running several businesses has taught me, if anything, that the world does not move to the beat of one drum - and to react rather than consider and act is a fool's game. I consider rigid adherence to dogmatic absolutes to be a sign of lack of experience, if anything.
When something like COVID-19 impacts, we perhaps don't just need to reconsider how we think about our goals, but we may need to change our very fundamental investment concepts.
What COVID-19 has shown us
You can certainly group me with the crowd who wouldn't believe that something such as this pandemic could have this sort of global impact. The notion that conservative investment segments such as the food industry, restaurants, or utilities could ever face the headwinds that they are currently facing is something I would have called supremely unlikely only a few months ago.
It goes to show us that, in the end, nothing is really safe. When dividend kings such as Sysco (SYY) suffer along with oil and energy stocks, at least short term, it shows us that diversification isn't just for some people - if you mean to survive on your investments, it should be one of the very basic tenets you follow.
People often ask me why I choose to diversify the way that I do - why I don't hold more than 5% in any one stock, and hold no more than 4% in 6 holdings in total. Why it is my goal to in the long run diversify into positions, diluting most, if not all, down to 1-3% at most. Many methods show that diversification to an extreme can be negative. I've spoken to this in earlier articles, but this again illustrates the point - diversification protects me from a significant dividend impact in times of trouble when they arrive. Not if, but when. When they do arrive, very little is indeed safe.
I expected Swedish and European companies to adjust dividends as soon as the extent of this crisis became clear.
It's something I've spoken to in articles, not just to Swedish but to European stocks as a whole. When the forward math doesn't make conservative sense to them, they either postpone or freeze, or even cut. No European stalwart I own has truly cut the dividend. All of them have postponed the payout decision until 2H20 - so there may be further impacts at this time if and when they decide to actually pay a lowered dividend or not pay a dividend for fiscal 2019.
What COVID-19 has shown us, in my view, is:
- Very, very few (if any) companies, stocks, or sectors are truly "100% safe", even in North America. In the end, our perception of safety, including dividend safety, is only in relation to the overall market conditions. Even my own "ultra-safe" stocks according to my very own model are safe only insofar as market conditions and company fundamentals allow.
- The belief that we can expect what will happen long term, or even what will not happen, is misguided - the fact is that anything can happen, and we can only prepare for what we assume may be the worst.
- Your investment strategy should never be copied from someone else, but should always be constructed around your own personal circumstances and forward expectations.
- The importance of focusing on quality, as opposed to riskier, higher-yield stocks. This is a subjective definition, of course, but I believe there are common denominators for stocks considered more "qualitative" than others, and these are the companies I focus on and follow.
My own expectations going forward
Being that I'm quite diversified, in terms of sectors as well as individual companies, my confidence is high that my investment method will safeguard what's the most crucial to me - my dividend coverage ratio and the overall continuing payout of my portfolio dividends from over 80+ companies.
This is the most crucial to me, as it represents my potential future earnings stream - much like a salary. In today's situation, I have no need to view it that way - I have a job, run a business, and continue to earn money that I can live off of, as well as invest. However, as I plan to eventually make money for the most part off my dividends, I use COVID-19 as a learning experience for what will happen to my portfolio during a crisis.
(Photo Source: Visee Finance Administratie)
I've modeled dividend cut forecasts and impact estimates to calculate what sort of short-term, mid-term, and long-term hit my finances are taking, can take, and potentially could take.
This is also valuable in terms of what sort of cash/cash-equivalent position I need to hold to consider myself "safe" long term. Previously, my calculations have shown that I need no more than 2% of my net worth in cash/cash equivalents to be able to weather any "natural" sort of storm - but current modeling shows the potential necessity of an additional buffer - perhaps 0.5-1%, bringing my potential cash/cash-equivalent target to 2.5-3%.
Notice that I'm not talking about selling anything due to dividend cuts. As of yet, I haven't sold a stock because the company cut the dividend or risked cutting the dividend. That's not a reason I sell a stock - I sell if a thesis breaks, and running a business myself, I realize there are happenings you can't plan for. I view it as irrational to penalize companies for things they cannot really plan for. So, at this time, I'm focusing not on whether the company cuts their dividend, but the underlying quality of the business itself.
Part of the point of this article is mapping - as in, mapping the risks in my portfolio and the potential impacts to my overall payout.
Risk mapping - These companies have, or may realistically, cut
Let's go alphabetically. I'm only going to mention companies I consider relevant here - meaning European companies that have postponed or not yet completely adjusted as a result of COVID-19 aren't necessarily included. In the end, this is an example of how you can view the potential impact on your income, not a company-by-company portfolio review. Those I save for the monthly updates.
However, these portfolio companies have cut or I strongly expect cuts here within 2-4 weeks.
1. Boston Pizza Royalties Income Fund (OTC:BPZZF)
Impact on portfolio dividend/expense coverage: Low (<0.5%)
This holding is a remnant of one of my earliest, non-European portfolio buys. The returns have been phenomenal over the long term given all the dividends received, and even with the crash in valuation, I'm far from in the red on this position. It's not a massive holding at around 0.4% allocation, but it's one of my few remaining monthly dividend payors - and as of a few weeks ago, they've completely frozen the distribution due to COVID-19. I understand the decision and can only hope that once Canada opens up, the discussions as to this seem ongoing, that things move back somewhat towards normalcy.
It's one of those holdings that you're sort of attached to, even if emotional attachment is a truly bad idea. I love the company's stuff (ate there many times when I visited Canada), and it has survived headwinds for a long time. However, to my knowledge, it has rarely communicated that it may no longer be in keeping with its debt covenants within 2-3 months.
In the end, and once/if things return to normal, this is a position I'm considering reinvesting in more conservative companies even at the inevitable result of an income reduction due to lower yield. There is always risks to royalty-structured income funds, and COVID-19 has shown that there are risks even to food companies that we cannot plan for, and which may affect overall long-term viability if things get bad enough.
At this time, I wouldn't invest in the company - nor would I going forward once things recover, as the company is no longer compatible with my long-term goals. Truth be told, it hasn't been for a while, but I've been dragging my feet for over a year here.
2. Meredith Corporation (MDP)
Impact on portfolio dividend/expense coverage: Low (<0.5%)
The company hasn't "cut" its dividend, but a pause is also causing concern. The decision, based on company finances and ad-related operating incomes during the crisis, is completely understandable, but it does go against previously communicated guidance as well as near-term liquidity and cash/cash-equivalent availability.
This goes sort of in line with the logic European companies are using to justify current changes to dividends. When the company is hurting, cost controls need to be enacted, and shareholder dividends, in the end, can be considered a luxury in times like these. The good part is that we have a timeline for dividend resuming, which seems to be when COVID-19 has dissipated and markets are opening back up, with ad revenues returning to normal.
This, however, could take months.
In the end, pausing of a dividend isn't enough to make me change my stance on Meredith. I bought it for overall fundamentals, and these fundamentals don't change because of this decision. I'm not buying more here - I view Omnicom (OMC) and Comcast (CMCSA) as providing better value in this sector, but I'm not worried about MDP in the long term. I invest, after all, for the next 10-50 years, not the next year or even 5 years.
3. Ocean Yield (OTCQX:OYIEF)
Impact on portfolio dividend/expense coverage: Medium (~1%)
This one is harder. As I'm writing this, Ocean Yield cut its already reduced dividend by another 2/3rd, to $0.05/share and quarter. While I expected the company to reduce further - the communication prior to this was very clear - this goes towards the lower end of my expectations, and the impact on my overall expense coverage from dividend is more than 1%, given my 1.02% allocation to Ocean Yield. It's probably the largest higher-risk holding I own.
The coronavirus has hit the company hard. I wrote an article about this which is slated to publish within one week with more details, but suffice to say that COVID-19 and the oil crisis have made temporary headwinds into actual, structural short- to medium-term issues for this shipping company.
We can't expect immediate recovery, and despite my long-term bullish stance, I recognize that my earlier positivity in the light of payout safety was perhaps a tad too bullish.
However, I do remain bullish long term on Ocean Yield because of its fundamentals. It has a fleet of 72 vessels, 68 of which are under a long-term lease with a $3.4 billion EBITDA backlog, and its new level of dividends is so conservatively calculated given the company's finances that it could pay this even during the most negative full years on record. This, combined with strong, aligned ownership, actually means that I'm reinvesting proceeds into Ocean Yield even at this level - albeit much slower than I was before.
The impact of the cut is medium-sized, lowering my overall expense coverage ratio by around 1.05% - which is harsh, but given my exposure, is expected.
4. Simon Property Group
Impact on portfolio dividend/expense coverage: High (>2%)
This is one I didn't expect a month or so ago, but it goes to show that even A-rated, ultra-safe considered giants can fall.
It's not a definite one yet, but SPG has a history of cutting the dividend despite liquidity strictly not needing it. The company reports next Monday, at which point we'll know. I, however, expect a 50% dividend cut from SPG next week. The company is my largest non-EU position at nearly 3.4% of my portfolio.
What do I base the expectation on, besides history?
- Research suggests that only 25% of April rent has been collected.
- Simon's superior locations don't mean anything when societies are closed.
- Tenants The Gap (GPS), L Brands (LB), Tapestry Inc. (TPR), Capri Holdings (CPRI), Macy's (M), J.C. Penney (JCP) and Neiman Marcus Group (NMG) are all in one form of dire trouble or another. Many of these represent top-10 tenancy positions for SPG.
- Grocery or mall anchors don't help when, again, societies are closed.
- 95% occupancy rate is good, but 7.6% of SPG's leases expire in 2020 and another ~2% are month-to-month, which can all be considered uncertain.
- Even once malls open up again, it will take time for traffic trends to return to normal levels - even if I personally believe they certainly will in time.
SPG went into the coronavirus phase with a 77% payout ratio for its dividend, so in theory, a 20% hit to the company's OCF should have been no problem. However, given how opaque forecasts and troubles are, it's not inconceivable that the company's payout ratio could start hovering close to 100%.
What's more is the company's intended signals to the market. Will it take the opportunity now that Disney and other companies and REITs have cut, and do the same to preserve cash? The move is unlikely to raise as many headlines or affect the stock as it would have months ago. If I were an SPG executive, I certainly would consider this to conserve cash for the future.
A 50% cut from SPG would lower my expense coverage from dividends by close to 3% - a horrendous figure if I were retired and depending on this cash to buy food. As it stands, I have zero worries about SPG in the long run - if a company can survive the mall apocalypse, it is SPG, Realty Income (O), and Federal Realty Investment Trust (FRT) - and I own shares in all of them. I'm reinvesting more into SPG, though at a slower rate than before, and I currently consider a 50% of current dividend as a yield target rather than the current one until more clarity is achieved.
5. Tanger Factory Outlet Centers (SKT)
Impact on portfolio dividend/expense coverage: Low (<0.5%)
Tanger was a company that looked excellent prior to, and in the very initial stages of the coronavirus outbreak. However, as the scope and consequences became clearer, it has transformed from a somewhat safe higher yield into an almost inevitable cut of the dividend. Previous guidance was negative, but the company's payout under these expectations was safe. It no longer is. The same reasons apply as with SPG, but due to the company's worse coverage and trends, headwinds are likely larger. To that comes the fact that unlike SPG, the company has added more and more short-term lease agreements with temporary stores as opposed to longer-term and safer leases - forget 2% as with SPG, this number is 6% for SKT.
Also, 10% of the company's leases are up for renewal this year, bringing the total portion of problematic leases to at least 16% - and that's before retailer headwinds. It's challenging for the company to fill the spaces at this time, and this is unlikely to improve. The risk, on the very negative side, is for a death spiral of lower occupancy leading to lower overall appeal for visiting outlet centers, leading to lower sales, and so forth.
The positives here do exist, such as:
- SKT does not have any debt maturities until 2023.
- It has access to a $600 million line of credit, with a 1-year extension until 2022.
- The cost for the dividend is $135 million, which would have been covered under previous guidance, and given the company's available liquidity, is still covered.
- The current valuation prices in a lot of bad news - history suggests a potential upside with positives could be in the works.
In the end, however, current circumstances, market situation, and alternatives to SKT make the company, as I see it, uninvestable here. This does not equate to company properties being worthless, and I have no intention of selling my SKT stake. The company's properties are far from worthless, and in terms of an outlet center company, I believe history confirms the quality we can find here. This is the holding where I consider a lot of "risk", together with Ocean Yield, yet I am still comfortable holding it going forward.
Wrapping up
These are the 5 companies I hold in my portfolio where I expect the hardest hits going forward. My current dividend coverage ratio in terms of expenses is around ~152% (of expenses covered only by dividends). My forecasting models show me that this could potentially fall by up to 12% as a result of these, and a few other small cuts. These are not the only companies where cuts are likely, but it is the companies where cuts have a significant impact on the coverage of my expenses.
My goal, as I bang on about in every single one of my monthly updates, is financial independence through dividend safety. Yet, for part of my investment career, my picking and method, as well as allocation, have not been aligned with the conservative ambitions and safeties which I now consider to be an absolute requirement for any investor seeking long-term financial freedom.
To put it succinctly, I've allowed myself on occasions in the past few years, to still be lured by the promise of high yields in order to boost my already impressive average dividend for the "sake of it".
This is great in good times, as payments during good times are mostly safe. However, if I were retired and for some reason without the ability to get any other sort of income, I would not be comfortable with the way my portfolio was structured going into the crisis. There would simply be too much of a risk of less-than-ideal dividend coverage, especially with European companies almost universally postponing all of their dividends.
I've often communicated for the past few months my intention to change this. I hope my picks and my strategy clarifications have emphasized just where my capital is flowing these days - and where it will flow now going forward.
I also hope that seeing just how little my overall dividend coverage is impacted by something like SPG potentially cutting its dividend in half gives you insight into my investment logic.
I have investor colleagues and friends who have lost over 50-60% of their annual dividends for 2020 due to overexposure to one sector/company or another (oil/real estate, most often). They saw themselves as already virtually retired, many of them. I know one impressive guy who retired at the age of 28 due to his successful investments in 12 Swedish dividend-paying companies who at this time has had to take on a job - which he never wanted to do again. Why? Because 9 of the companies postponed their dividends, and he didn't have enough savings on hand. A week ago, he came to me seeking to turn his 12 holdings into at least 80, and preferably international ones.
My point, dear reader/s, is that you need to consider your goals and make certain your current investment methodology aligns with your psychology, temperament, and your financial circumstances. My point in this article isn't to show you "This is how I failed", but rather, "These are the real-life actual effects of dividend cuts to someone who calculates long-term safety - learn from them!"
If you think that I made mistakes, focus on them and don't repeat them!
I know that some people espouse the "income method", where hypothetical safety/investment goals are found in many higher-yielding and theoretically conservative equities and debt instruments. I admire this - though I could never do it, as it would be the opposite of being able to sleep at night for me.
My objective is, and continues to be, to buy quality at a discount. I want dividends, but I don't sell if I don't get them for a year or so if the company's reasoning is valid. I have stringent rules and I don't like to sell, but I don't deal in absolutes - I view them as foolish.
I hope that in the end this article is of interest to you or cracks a smile. Perhaps it entices you to look over your own portfolio and model the effect of dividend cuts - I encourage you to do this!
Above all, however, keep a cool head, don't react - analyze - and stay safe out there.
Until next time.
