A Word About Dividends

Over the years we have often written about the importance of dividends to our Core Equity Strategy. In particular we have been drawn to companies with the ability and inclination to grow their dividends over time above the rate of inflation. Recently, there has been much written and broadcast about the large number of companies that have reduced or eliminated their dividends due to economic weakness in the U.S. caused by the Coronavirus pandemic. Indeed, there has been a notable pickup in dividend cuts and we have seen this happen with three of the companies that we own in the strategy. However, we want to stress several points here. First, three sectors have seen the brunt of the dividend cuts – energy, industrials, and consumer discretionary (primarily travel, retail, and big-ticket items). Second, many companies are still increasing their dividends, including 10 companies in the strategy.

As everybody knows, the economic hit from the Coronavirus has impacted some sectors harder than others. Brick and mortar retailers, with their stores largely closed, have seen their sales drop dramatically and free cash flow turn negative. Macy’s, Nordstrom, Kohl’s, Ross Stores, TJX Corp., Office Depot, and Dick’s Sporting Goods have all suspended their dividends over the past two and a half months. In the restaurant sector, Darden Restaurants, Yum China, and Dine Brands Global have done the same thing as has Estee Lauder, whose cosmetics are sold largely through department and specialty stores. The energy sector has been hit by reduced dividends due to lower economic activity and less driving and a dramatic drop in the price of crude oil, that briefly fell below zero in April. Marathon Oil has eliminated its dividend and Schlumberger and Royal Dutch Shell substantially reduced their payouts. In the travel arena all the major airlines have eliminated dividends, as have many hotel chains. Both Ford and General Motors have announced recently that they were discontinuing their dividends, as did Goodyear Tire; and Harley Davidson cut its by 95%. You get the picture. There has been plenty of dividend activity on the negative side and in many high-profile, recognizable names.

In the strategy, three companies have eliminated their dividends – Disney, Las Vegas Sands, and HCA Healthcare. In the case of Disney, its parks have been closed and the absence of major sporting events has impacted the network business. The company has also been unable to generate new movie and television content, also negatively affecting cash flow. Las Vegas Sands operates casinos in Las Vegas, Singapore, and Macau. Simply put, its casinos have been closed beginning in the first quarter of 2020. The company was profitable in the first quarter but is expected to lose money in QII. HCA Healthcare is the nation’s largest for-profit hospital chain. While its Coronavirus-related business was active in recent months, elective surgeries were down considerably, impeding cash flow. We have a high degree of confidence that Disney and Las Vegas Sands will bring back their dividends over the near-intermediate term as both companies have solid balance sheets and very solid positions in their respective industries. In fact, we believe that both companies could emerge even stronger. We have some comfort that HCA will bring back a dividend though the company’s more leveraged balance sheet, created largely by a 2006 LBO, keeps us from having as much conviction as in the case of the other two companies.

On the positive side, ten companies in the portfolio have raised their dividends since mid-March. These include, in order of percentage increase:

As can be discerned, the dividend raisers are across a variety of industries (technology, healthcare, consumer staples, consumer discretionary, finance, and industrials) and all ten increases are nicely above the current rate of inflation.

We continued to keep a sharp eye on free cash flow for the companies that we own (and are looking at) as this is a key metric in judging the ability to pay dividends. Free cash flow was generally flat-down slightly in the first quarter of 2020 versus one year earlier for our holdings. Second quarter numbers will be more telling in this measurement and, at this point, we see continued declines versus year-earlier numbers. The vast majority of our companies paid out under 50% of free cash flow as dividends in 2019. This means that most companies could generate a lower level of free cash flow and not be in danger of jeopardizing being able to generate the cash required to continue to pay and/or increase their dividend.

With 3 ½ weeks left until the close of the second quarter we are pleased the strategy has not had a great deal of cash, taking good advantage of the recent rally in stocks.

The KKRA Team