What to expect from dividends this reporting season

Welcome to the first episode of '4-minute Monday', a special series from Nikko AM built around ASX reporting season. Each Monday, I sit down with the team and summarise highlights of the prior week to give investors a pulse of company earnings as well as forward-looking views into upcoming results. I hope this material helps you make sense of the deluge of announcements typically associated with earning months.

This first week of reporting season was relatively quiet with most companies set to report later in the month. In this wire, I discuss the standouts results of week one, my expectations for AGL and my thoughts on the future of dividends for this period. 

It's been more than a year since COVID-19 stopped the world in its tracks. Overall, how has it impacted company profits?

2020 was a tragic and extraordinary year. From the perspective of financial markets, it was impossible to envisage what transpired. Australia experienced one of the deepest and quickest recessions in history and the divergence in how companies and sectors were impacted by COVID-19 has been extraordinary.

We've witnessed wide-ranging impacts; everything from consumer staple companies like Coles, Woolworths, Wesfarmers, and even Metcash seeing huge sales growth throughout the COVID-19 lockdowns and rest of the year. Likewise, a number of consumer discretionary retailers, such as Harvey Norman, JB Hi-Fi, and a number of online retailers also saw huge increases in sales and therefore profits. On the flip side, the travel and hospitality industries experienced the inverse of this. Businesses were closed for much of the year and are still struggling today given Australia’s intermittent state and territory border closures and the current, permanent international border closure.

Given this backdrop, were there any standouts for you in week one?

The first week of reporting season saw very few companies of note reporting, but coming into the results, the confession season has largely been positive to benign.

We've seen both retail and housing-exposed stocks deliver strong operating results and, therefore, reasonably significant upgrades in companies such as Reliance Worldwide (ASX: RWC), as well as a number of the consumer discretionary stocks.

The ongoing reduction in deferred loan balances on the banks, both in mortgages and SMEs, has significantly reduced the tail risk around bad debts. We believe banks are well provisioned for the bad debt cycle expected to post the rolling off of the COVID-19 support packages. The growth in mortgages, due to the buoyant housing sector, is also an obvious positive for the banks.

Overall, we believe the companies reporting will be quite cautious in their commentary, but we expect this season will be more positive than what we saw in August 2020.

AGL announced that it will write off close to AUD3.6 billion in provisions for onerous contracts and environmental remediation. What's your expectation for their results?

AGL has been in a downgrade cycle since 2017 and this recent update continues this trend. The increase in renewable energy capacity continues to put downward pressure on wholesale pricing and we don't expect this to change anytime soon. This impacts AGL's margin and profitability, significantly. This situation will continue until large coal generation facilities are shut down, which will occur over time. But that's more of a longer- to medium-term prospect.

The situation seems quite unsustainable given that both Origin and AGL generation assets are arguably unviable at current prices. The market, therefore, will eventually revert at some stage. So, it's difficult to foresee anything positive coming out of the AGL result; albeit, hopefully all the bad news has been released.

Do you expect to see a repeat of August’s reporting season where dividends were down across the board?

We expect dividend news will be slightly better than what occurred in August 2020. Resource companies, in particular, are expected to have quite strong dividends, particularly the iron ore miners, such as BHP, Rio and Fortescue, given the very high iron ore prices and high margins they're receiving.

Likewise, retailers should have strong profits and therefore dividends should be quite good. We're expecting banks to provide much better operating outlook statements and comments around dividends will be much improved from August 2020. The combination of increasing profits, payout ratios moving higher and the removal of the APRA restriction on dividend payments should result in bank dividends rising over the next few years.

However, we do expect many companies to remain cautious in both outlook and dividends in February’s reporting season given the ongoing uncertainty around global issues on COVID-19.

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Throughout February, I will publish my thoughts on all the biggest news from reporting season, including a look back on the week that was, and the things to look out for in the week ahead. Hit the follow button to stay up to date.