Companies that cut their dividends amid last year’s pandemic and where are they now?
For twelve years, the team at Keeley Teton Advisors has managed strategies focused on small- and mid- cap companies that pay dividends. We think we have learned a few things about this subsegment of the equity market and we think our clients and others might be interested in learning more about this area. Consequently, we are rolling out a new semi-annual report, the Keeley Teton Dividend Tracker. Every six months, we will discuss the make-up and changes in the dividend universe, with a particular emphasis on small and mid-cap stocks. We will also do a deep dive on a topic of interest. In this edition, we look at what happened to the companies that cut their dividends amid last year’s pandemic. We hope you enjoy it and appreciate any feedback.
The Dividend Universe
The Russell indices see a lot of change in June when Russell performs its annual reconstitution. Changes during the rest of the year are mostly driven by the addition of newly public companies offset by the acquisition of companies.
- The percentage of companies in the Russell 2000 paying dividends declined across both style categories because of the rebalancing. Only 8% of the 300 companies entering the Russell 2000 index paid dividends whereas 33% of the 357 companies leaving (from rebalancing or acquisition) paid dividends.
- The percentage of dividend payers in the Midcap index remained steady and picked up significantly in the Midcap Growth index.
- It seems to be expected for large cap companies to pay dividends. It is kind of interesting that even large cap growth companies are as likely to pay a dividend as midcap value companies.
- Also noteworthy is that whereas larger companies in the Russell 2000 are more likely to pay dividends (weight of dividend payers > percentage of dividend payers), it is the opposite for large caps. This is probably a function of the fact that some of the largest companies by market cap (Amazon, Alphabet, Facebook, Tesla) do not pay dividends. In midcaps, larger value companies pay dividends while smaller growth companies pay dividends.
Because dividend increases are often seasonal (companies raise their dividend the same time every year), we look at the year-over-year change in indicated dividend.
- The column titled “Avg. Increase” presents the average increase of the companies raising their dividend, not all dividend paying stocks. It is highly impacted by some outliers. For example, health insurer Cigna increased its dividend from $0.04 per year to $4.00, a 9900% increase!
- The percentage of companies cutting, suspending, or omitting dividends has dropped back down to pre-pandemic levels. This is probably close to the baseline level of cuts and suspensions. Some of this baseline is related to one-off companies getting into some financial distress, but much is related to companies suspending their dividends after they agree to be acquired and some is also related to spin-off activity where a company adjusts its dividend to account for the divestiture. For example, when VF Corporation spun-off Kontoor Brands in 2019, it adjusted its dividend to reflect the reduced scale of the company and the fact that investors would receive income from the shares of Kontoor.
- The percentage of companies raising dividends has not recovered to pre-pandemic levels, except in small caps.
- These trends, in combination with the mid-year reconstitution, result in dividend-payers being a smaller percentage of the universe across all capitalization ranges
Yields and Returns
The table above presents the simple average of the yield on the dividend paying stocks within each index. The yield on the index is lower because not all stocks pay dividends.
- Yields fell for most indices as dividend increases did not keep up with price appreciation. They fell the most in small caps where the minimum market cap to be in the Russell 2000 rose significantly from a year ago. This led a significant number of small banks, which generally have higher yields, to fall out of the index during the June reconstitution.
- Dividend-payers generally performed in line with the overall indices in the first half. Outliers included the Russell 2000 Value index on the negative side and the Russell Midcap Value index on the positive side.
Feature: Where are they now?
Between 2010 and 2019, we saw three significant corrections in the market (2011, 2015-16, and 2018). In each case the Russell 2000 fell by more than 20%. In each case, there was little impact on the economy. In each case, there was little impact on companies’ dividend policies. Despite the shortness of the 2020 downturn in the markets, the developments in the real world led more companies to reduce or suspend their dividends than had done so since the Global Financial Crisis. We thought it would be interesting to look at where these cuts took place, how much recovery has taken place since then, and what happened to the stocks of the companies that lowered their payouts.
Where Were The Cuts?
As the chart below shows, a significant number of companies that had planned to pay dividends in 2020 either reduced their payouts or cancelled them entirely. To put these numbers into perspective, in “normal” times you might see a mid-single-digit percentage of dividend payers in the Russell 2000 lower or suspend their dividends. This percentage is lower in the mid-cap universe and is almost non-existent with large caps. The sheer level of reductions is noteworthy. The other thing that stands out is how the reductions are clustered in relatively few sectors.
- In general, small companies were more impacted and businesses that were closer to the consumer were hurt more than those that served corporate customers.
- Companies were more likely to omit their dividends than just cut them. That is surprising to us, but makes sense when you remember the uncertainty Boards and managers were facing a year ago.
- More than 40% of companies in the Consumer Discretionary sector cut or omitted their dividends and large caps were not spared from the impact in this sector.
- The plunge in oil prices drove smaller companies in the Energy sector, already reluctant dividend payers, to cut back sharply on payouts.
- Small cap REITs did a poor job in sustaining their dividends with more than 40% cutting or omitting. Generally high leverage and concerns about the health of tenants drove the cuts.
- Real Estate, Energy, and Consumer Discretionary repeated their disappointing performance in the Global Financial Crisis as some of the sectors with the highest propensity to cut or suspend their dividends.
- On the positive side, Financials performed extremely well with many of the cuts and suspensions coming within the Mortgage REIT subsector of Financials.
Have The Dividends Come Back?
In a word, No. As the table below illustrates, the companies that cut their dividends are still far from restoring them to their pre-pandemic level.
- There does not seem to be that much difference amongst capitalization classes in how deep they cut.
- Fewer than half of the Cutters have raised their dividends since the cut. Of these, about 43% have an indicated dividend that are equal to or greater than where they were at the end of 2019. For mid-cap companies only two of the sixteen that cut, then raised, have restored, or exceeded their prior dividend.
- Less than half of the Russell 2000 Omitters are back to paying dividends. Within this sub-group, however, 54% of these companies have a dividend that is greater than or equal to the pre-pandemic payout. Within midcaps that suspended their dividends, a little more than one-third are back to paying dividends and only 22% have fully restored them.
- There are not enough large-cap Cutters and Omitters to draw conclusions.
How Did The Stocks Perform?
The most surprising aspect of our study (to us) is how well the stocks of companies that lowered their payouts have performed as the market recovered (see the table below). In thinking about why this was the case, we weigh the likelihood that stronger companies would be in a position to benefit more from upheaval in the economy against the possibility that the companies that cut their dividend are riskier and therefore have higher betas. In a rising market, a higher beta group of stocks would be expected to outperform (all else equal, which it never is). At least for this period, it looks like beta won.
- Not surprisingly, companies that cut or suspended their dividends underperformed since the end of 2019. This underperformance was due to steeper drops in share price in the first half of 2020. Cutters and omitters actually outperformed as the market came back over the last year.
- These observations are also generally true if you account for the sectors in which these companies operate. In very rough terms, the sector accounts for about half of the underperformance on the way down. As an example, the Cutters within the Russell 2000 declined 37% in the first half of 2020. This compares with a 13% decline for the Russell 2000 and a 25% decline for a benchmark that we calculated by a simple average of the performance of each stock’s sector.
- Omitters performed worse than Cutters in the Russell 2000 on the way down, but were not much different in mid-caps or large-caps.
- The Cutters/Omitters performed much better than the market on the way back up, but not enough to offset the initial decline. Interestingly, over the full timeframe, Omitters performed better than Cutters due to their stronger rebound.
- On the way back up, it does not seem to have helped to raise or reinitiate the dividend. The exception to this observation: We saw slight outperformance during the recovery from companies that cut or suspended their dividend temporarily but now have an annual rate greater than it was before the pandemic.
- Interestingly, the companies that ended up raising or reinitiating performed much better than those that did not in the initial downdraft. It seems the market did a good job in figuring out which companies were vulnerable to a more enduring setback.
While it is impossible to draw firm conclusions from one period of data, particularly one as unusual as the last eighteen months, we think it is useful to look at what happened to see if we can learn any lessons or gain any insights. With the appropriate caveats, we think two things stand out that we will incorporate into our investment process. First, the effort to try to avoid stocks of companies that cut their dividends certainly seems worthwhile. That is something we already do, but will probably increase in emphasis. Second, it is probably not good policy to quickly eliminate stocks if they cut their dividend, at least during a broad-based retreat in the market. Furthermore, if you continue to hold these stocks, not much investment consideration should be given to the timing of a re-initiation of the dividend or an increase in a reduced dividend unless you are confident that the dividend will quickly exceed prior levels.