Fund managers fish for dividend plays amid sharp cuts

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Some dividend fund managers are wading back into the shares of battered railroad stocks, energy companies and other economically sensitive, cyclical names, even as a host of companies have slashed their payouts.

Cyclical stocks were among the worst-hit S&P 500 (.SPX) sectors in March’s sell-off, with the group (.GSPD) losing as much as 33% from its highs amid fears that a coronavirus-fueled economic slowdown will deal an outsized blow to companies’ businesses.

More than 15 companies in the benchmark S&P 500 - many of them cyclical names - have either suspended or cut their dividends in the last four weeks. On Thursday, Royal Dutch Shell PLC (RDS/A) cut its payout for the first time since World War Two as part of a plan to save $30 billion to help it weather an unprecedented decline in oil demand.

Yet some managers of divided funds - which seek to give their clients exposure to a steady stream of income - believe the beaten-down sector may hold companies that are likely to keep their dividends intact and see their share prices rise. The sector has rebounded 28.5% from its March lows, compared with 26.3% for the S&P 500.

“The initial moves were very emotionally based and now we’re getting back to fundamentals,” said Scott Davis, a senior portfolio manager at Columbia Threadneedle Investments who oversees $24 billion in income strategies. “There is still going to be volatility but we think you can pick your spots.”

Davis has recently added to positions such as Home Depot Inc (HD), Chevron Corp (CVX) and Union Pacific Corp (UNP) that have attractive free cash flows despite being in industries that have been among the hardest-hit by the slowdown. Both companies offer a dividend yield of approximately 2.5%.

Companies like Walmart Inc (WMT) and Home Depot that have free cash flow growth above 6% will likely be able to invest and grow their market shares during a recession, while those such as Macy’s Inc (M) could end up in bankruptcy, he said.

“I have a feeling that some of those trends that were already in play will only get accelerated,” said Davis.

U.K. and European companies will likely cut dividends more than their U.S. counterparts, which are more likely to reduce share buybacks first, said Mark Peden, investment manager, Equities, at Kames Capital.

Companies like cruise line operator Carnival Corp (CCL) and British retailer Marks and Spencer Group PLC (MKS) likely will not restore their dividends to previous levels, but other companies will want to increase theirs as early as possible to demonstrate their financial health, he said.

While dividend-paying stocks may provide the cushion of a payout, their dividends - and share prices - could be in jeopardy if a subsequent wave of the virus deals another blow to growth by forcing countries to reinstate or extend lockdown measures.

Analysts at BofA Global Research urged investors to focus on companies whose dividends are likely to be secure, rather than comparatively rich.

“The massive economic disruption brought on by COVID-19 questions the sustainability of dividends,” the bank’s analysts wrote.

At the same time, historically low borrowing costs have prompted many companies without strong balance sheets to initiate dividends since the end of the 2008 financial crisis, noted Linda Bakhshian, a portfolio manager at Federated Hermes.

While many of those companies will be forced to cut their dividends, cash-rich firms in growing sectors like healthcare and technology are the most likely to maintain or even increase their payouts through what could be a painful recession ahead, she said.

“You’re going to see soon which companies are going to come out of this on the other side stronger,” she said.

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