From Lombard St :
Low rates are supporting equity valuations, but the risks to corporate earnings from a fragile macro backdrop are on the rise, challenging the sustainability of the Australian market’s generous dividends.
Despite the deceleration in earnings, dividend payout ratios have surged from 55% to well over 70% in the last four years. High dividend yields have been instrumental in helping the bank-heavy (ca. 50% weight) ASX200 benchmark index shrug off the end of the commodity supercycle. However, this tailwind is weakening. The stock market has been on the back foot since April, when the major banks announced smaller-than-expected interim dividends.
A confluence of headwinds is facing Australian banks, which have now switched to capital-raising mode. Margins are shrinking and earnings have come under pressure from escalating competition and the sluggishness of the economy. In addition, capital adequacy requirements are getting tougher, not least in view of elevated exposure to pockets of froth in the property market. Post-crisis, the major banks have not just shifted away from business lending to residential mortgages. They have also flattered their capital ratios by slashing the risk weights applied to home loans (from 50% to less than 20%) – a reduction sharply at odds with declining affordability and surging price-to-income ratios.
In contrast, the big mining companies – dominated by BHP and Rio Tinto – have stuck to their ‘progressive dividend policy’ of at least maintaining the US$ dollar value of their payouts. But with profits contracting, they have increasingly funded these dividends by cutting costs, disposing of non-core assets, tapping debt markets and severely reducing investment. In this regard, lower oil prices have added fuel to this ‘carry trade’ by rendering incremental production cheaper. However, such a strategy should eventually run up against its limits, especially if volumes of iron ore exports to China catch up with the decline in prices.
Yep, though gearing remains low so the big end of town will be able to borrow and dump dividends through the end of the cycle.
