Dividend drought looming for South African investors

South African investors are likely to face a dividend drought soon, with companies unable to pay dividends due to the tough operating environment and an uncertain economic outlook.

This is according to a portfolio manager at Sanlam Investments, Roy Mutooni, who spoke to CNBC Africa about the growing trend of South African companies opting not to pay dividends.

Mutooni said that the rising cost of capital with increasing interest rates is not determining whether a company chooses to pay dividends. Rather, it results from a difficult operating environment and a negative economic outlook. 

Companies are choosing not to pay dividends out of prudence, as many would prefer to use that cash as a buffer against future shocks. 

“You have to make a rational choice as a management team. Where does the next rand go? Where does it give you the most bang for your buck?”

In particular, companies have had to redirect money to mitigate the effects of load-shedding through generators or alternative power sources. This money usually comes out of dividend payments and general capital expenditures.

However, highly cash-generative businesses may continue to pay dividends as they can maintain a strong balance sheet while giving investors dividends. 

Mutooni also said investors could use dividends to indicate how healthy a business is. 

When a company pays out a dividend, it usually indicates good cash flow generation, a strong balance sheet, and a stable outlook.

In volatile times, dividends can be used to distinguish between companies that can withstand external shocks without a significant impact on their business operations.

However, investors should be wary when a company skips dividend payments or changes its dividend policy, Mutooni said. 

Regardless of the operating environment, when a company skips a dividend payment, it usually indicates internal issues. 

He pointed to the examples of MultiChoice, Spar, and Telkom, who all chose not to pay dividends last month. All of these companies had internal problems. 

Mutooni advised investors to always ask why a company skips a dividend payment and do deeper research. 

In particular, investors should look at how the company’s executives are rewarded, as the interests of management should always be aligned with shareholders. 

If dividends are skipped, it should not be to boost the executives’ salaries. Companies should never say, “We can’t pay you, but we will pay ourselves more.”

This undermines management’s credibility and raises questions about the future of the company.