Is dividend income safety under threat?

Some of the most powerful companies that are doing very good business just now - such as the supermarket leaders Coles and Woolworths or utilities such as Telstra - could actually lift their dividends.

“Dividend traps” are increasing across the market as nominally high dividends and attractive rights issues capture attention.

With one of the highest dividend rates in the world, the local market is often presented as a secure source of income for investors - especially older investors who can have their ultimate returns boosted by franking credits.

In theory, investors who are in the sharemarket primarily for income can “ride out” reversals as long as dividends remain steady or close to previous levels.

But dividend income is now in jeopardy with talk of key companies trimming dividends or at worst, not paying them at all if conditions deteriorate from here.

Making the problem worse is the slew of capital raisings that are now on the cards with new share purchase plans or related variations being announced on a daily basis.

Already the list includes Cochlear, Flight Centre, Oil Search and Kathmandu.

Capital raisings can dilute dividends per share - there is quite simply less money to go round.

Across the market, advisers are warning clients not to be fooled by the current high dividend yield that has occasionally come close to 6 per cent during the crisis. The average in the market over recent years was closer to 4 per cent.

In particular, advisers point out that dividend yields have jumped higher at almost every company primarily due to a share price plunge.

At NAB, where the share price has nosedived from $27 to $16, the stock is now running with a very unconvincing forecast dividend yield of around 10 per cent.

It is highly unlikely the bank - or its new boss Ross McEwan- will want of offer a dividend that works out at 10 per cent of the bank’s share price.

No wonder then that experts in the area such as Dr Don Hamson, who runs Plato Investment Management, is suggesting that we could see a 30 per cent drop in dividends across the board in the local market in the months ahead.

Hamson believes that among the companies most at risk of cutting dividends are three of the big four banks - ANZ, NAB and Westpac. Along with toll road group Transurban, Oil major Woodside and shopping centre group Scentre.

Interestingly, Hamson says it might not all be one-way traffic.

Some of the most powerful companies that are doing very good business just now - such as the supermarket leaders Coles and Woolworths or utilities such as Telstra - could actually lift their dividends.

“We just don’t know yet,” he explains.

Some forecasts are considerably more ominous.

Looking at global dividends, the chief global equity strategist at Citi, Robert Buckland, suggests that earnings per share on world markets could fall 50 per cent and “dividends could fall almost as much”.

On top of the fragility of current dividend yields, the rush of capital raisings has the potential to reduce returns further as dividend payments are suppressed by the enlargement of shares on issue.

During the GFC, which had strong parallels in terms of market action, dividends dropped by 16 per cent but dividends per share fell by 30 per cent.

Many investors who are long-term holders of blue chip shares will not be able to avoid dividend cuts, but advisers warn against “topping up” on the basis that dividends still look attractive.

The government has already confirmed that franked dividend changes are not being considered during the current crisis. which will be a relief for many investors.

“In a way the decision to leave franking alone during these difficult times is one of the few things that has actually been done for retirees and self managed super funds,” says Hamson at Plato.