Amit B. Wadhwaney is the portfolio manager of Third Avenue International Value Fund, one of several funds managed by US value investment firm Third Avenue Funds. In his recent quarterly missive to unitholders, Wadhwaney explained that he had sold his position in Australian building materials group CSR, citing management’s decision ‘to launch a rights issue rather than cut back its capital expenditure program and reduce its generous dividend.’
This highlights a key difference between the US and Australian corporate landscapes. In the US, share buybacks generally take precedence over dividends as the preferred method of returning funds to shareholders for tax reasons.
The problem is that, generally, companies are flush with cash in the good times and that’s also when their share prices are sky high. And the unfortunate outcome is the same whether an investor directly purchases overpriced shares or a company’s management does it on their behalf.
For the most part, I’m a fan of Australia’s rules and attitude towards dividends. The dividend imputation system is an efficient way to encourage companies to return excess cash to shareholders and a company’s dividend policy imposes a certain discipline on management. Changing dividend policy sends a strong signal to shareholders regarding profitability or a change in strategy, which then gives investors control over the type of companies they wish to include in their portfolio – growth or income stocks, for example.
There are also very few businesses and managers that can reinvest profits at high rates of return. That being the case, profits are generally better paid out to shareholders who can then decide where their capital ought to be invested.
Yet in the current environment, the fact that management teams and boards feel compelled to pay out dividends is leading to bad news for long-term shareholders. As Wadhwaney alluded to, a dilutive capital raising seems more palatable to many Aussie shareholders than a dividend cut. This is short sighted, if not self-deceptive (putting in more capital to allow the company to continue paying an unsustainable level of dividends).
Large capital raisings place a ball and chain around future earnings per share (EPS) growth and, as long term investors, it’s something we should rally against. Take Billabong’s recent 2-for-11 non-renounceable rights issue, for example. Ignoring the retail component, large shareholders coughed up $230m, which will increase shares on issue by around 15%. Yet retaining profits and not paying dividends for the next 18 to 24 months could have avoided this permanent dilution. Now when profits recover, EPS growth will be that much weaker.
Australian shareholders have become hooked on dividends at a cost that will reveal itself during the recovery years. There are certain groups who will argue that they depend on dividends, to pay their grocery bills or margin loan interest, for example, but there is no preordained rule that states a company must pay a dividend. We should all invest accordingly.
No one enjoys receiving a dividend more than this author, but not at a substantial long term cost. If, like me, you’re convinced that in many cases, temporarily foregoing a dividend will be in shareholders’ long-term interests, then it’s time to take action. We should join together at this year’s crop of annual meetings to form, perhaps, the strangest picket line ever:
What do we want? A dividend cut! When do we want it? Now!
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