Focus on dividends – Telefonica’s cut doesn’t scare Spanish yield investors

The recent decision by Spanish telecom giant Telefonica to cut its dividend, for the first time since Spain’s Civil War, confirmed a wider concern some investors feel that the country’s companies will have to review their distributions ever more as the domestic crisis worsens.

Telefonica has a €57bn debt pile, and said it was committed to reduce in order to protect its investment-grade rating.

Its dividends, and equity income investors hoping for them, were the casualties.

The worsening of the financial health of the country, as well as government policies, could see other companies following the lead.

Spanish oil and gas company Repsol is another company investors are watching carefully, after it was reportedly ready to do “whatever it takes” to save its investment grade rating, including up to €2.5bn of disposals of liquefied natural gas assets, or redeeming preference shares.

Banks are also under severe pressure since the crisis, and as a result of government demands they set aside sufficient provisions against toxic real estate assets.

Santander posted a net profit of €1.7bn at the end of the first half, down 51% from the previous year, after it wrote down €2.8bn for bad loan losses.

All three stressed sectors – financials, telecoms and oil and gas – play prominent roles in dividend funds.

However, the outlook for Spain is not likely to affect the strategy of high dividend managers, according to Frederic Jamet, head of investment at State Street Global Advisors (SSgA) France.

“The focus should not be on companies, but on the need of the investor for this kind of strategy. Investors need high dividends because on one side there is a context of low yield on cash, and high-rated government bonds, but also because high dividend strategies have shown positive outperformance in the past. Both those reasons remain in place in the Spanish market,” he said.

The impact of the dividend cut, as in the case of Telefonica, depends on the market reaction to the announcement.

“If this is understood as an intelligent measure in order to control cost and maintain capability to invest in the future, the stock shouldn’t experience a durable drop in price. On the contrary, if this is an emergency signal on the lack of control of the finance of the firm, the drop in price could be significant,” Jamet said.

According to the manager, this paradox could keep the interest for the strategy healthy.

“If the announcement of decreasing a dividend is well perceived by the market, the price of the stock will not drop, but the dividend yield will drop. On the other side, if the announcement is badly perceived, the stock price will drop, and the stock will remain in the high dividend yield universe – although it decreases its dividend and the price has dropped,” he said.

Generally speaking, dividends are supposed to be the secured part of the profit and a diminution of the dividend for a non-cyclical stock such Telefonica is not a good signal.

In this specific case, though, the impact is likely to be mitigated by the fact that most of Telefonica’s large European telecom peers share the situation, with high dividend distributions and high levels of debt.

“This is why it is important to mix a growth or a quality feature into any high dividend strategy.”

SSgA has seen some large inflows in its type of strategies, which effectively mix the desirable high dividend yield with the comfort of increased dividends over a long period of time, Jamet said.

An interesting feature of the strategy is its capability to continue to deliver high dividend yields in the future.

“Any measure that impacts the cash level of companies or future capability to distribute growing dividends may have an impact on the performance of the strategy, but not on the reason to select the strategy,” Jamet added.

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