Question

Throughout the financial year (FY) 2008/2009, world markets experienced the depths of the global financial crisis (GFC). The collapse of the US investment bank Bear Sterns in March 2008 precipitated a rout on those markets that saw the Dow Jones Industrial Average Index drop from over 14,000 points in October 2007 to less than 7,000 points by March 2009. The resulting global contraction in economic growth created challenging operating conditions for Australian companies. Among the decisions confronting financial officers was that of what to do about dividend policy: should dividends be cut to match declines in earnings or should they be maintained at existing levels, resulting in an increase in their dividend payout ratio?

Table 1 below provides data on the earnings and dividend payments of four selected Australian Securities Exchange (ASX) listed companies for the period surrounding the GFC. The companies are: Australia &New Zealand Banking Group Ltd (ANZ), Westpac Banking Corporation Limited (WBC), Suncorp Group Ltd (SUN) and Downer EDI Ltd (DOW). The data in the table was sourced from individual company statements.

As we can see from the table (in which figures of particular interest are shown in bold type), the dividend payout ratios of all of the companies increased around the time of the GFC. For example, ANZ paid out the same total dividend ($1.36) in the financial year ended June 2008 as it did the previous year, despite the 28%decline in its earnings per share (EPS) from $2.048 in the financial year 2006/2007 to $1.478 in the financial year 2007/2008. This resulted in the company’s payout ratio increasing from the typical figure of around 60–5% of earnings in other years to 92% of earnings in financial year 2007/2008. Westpac was able to increase both its earnings and its dividends in the first year of the financial crisis but was forced to slash dividends and increase its payout ratio in the financial year 2008/2009 as the crisis began to bite. Likewise, both Suncorp and Downer EDI increased their payout ratios above ‘normal’ levels during the financial years 2007/2008 and 2008/2009.

These figures illustrate the difficulties that financial managers face in setting dividend policy, particularly during an unprecedented crisis such as the one that occurred between 2007 and 2009.

Table 1: Dividend payout ratios for selected Australian companies between the financial years (FY) 2005/2006 and 2009/2010

ASX code	Data	Financial Years
		2005/2006		2006/2007		2007/2008		2008/2009		2009/2010
ANZ                DPS (cps)
	-Interim	56.00		62.00		62.00		46.00		52.00
	-Final	69.00		74.00		74.00		56.00		74.00
	-Special	0.00		0.00		0.00		0.00		0.00
	-Total DPS	125.00		136.00		136.00		102.00		126.00
	EPS (cps)	188.65		204.81		147.83		166.52		195.00
	Payout Ratio (%)	66.26		66.40		92.00		61.25		64.62
WBC               DPS ($)
	-Interim	56.00		63.00		70.00		56.00		65.00
	-Final	60.00		68.00		72.00		60.00		74.00
	-Special	0.00		0.00		0.00		0.00		0.00
	-Total DPS	116.00		131.00		142.00		116.00		139.00
	EPS (cps)	163.66		183.02		194.31		121.68		189.50
	Payout Ratio (%)	70.01		70.70		72.18		94.16		72.45
SUN               DPS (cps)
	-Interim	47.00		52.00		52.00		20.00		15.00
	-Final	50.00		55.00		55.00		20.00		20.00
	-Special	0.00		0.00		0.00		0.00		0.00
	-Total DPS	97.00		107.00		107.00		40.00		35.00
	EPS (cps)	157.10		149.59		56.39		31.11		64.39
	Payout Ratio (%)	58.24		67.47		178.97		128.58		54.36
DOW             DPS (cps)
	-Interim	12.00		13.00		13.00		13.00		13.10
	-Final	8.00		8.00		12.50		16.00		16.00
	-Special	0.00		0.00		0.00		0.00		0.00
	Total DPS	20.00		21.00		25.50		29.00		29.10
	EPS (cps)	44.67		49.25		45.88		50.90		57.10
	Payout Ratio (%)	43.24		41.18		53.68		55.03		49.22

(a) DPS denotes dividends per share

(b) EPS denotes earnings per share

(c) cps denotes cents per share.

Requirement 1:

An examination of the payout ratios of Suncorp Group Ltd in financial years 2007/2008 and 2008/2009 finds them to be above 100%. Why would the organisation pay out more as a dividend than it generates in earnings?

Requirement 2:

Why might Downer EDI have chosen to increase its dividend payment in FY2007/2008, even though its earnings per share declined in that year?

Answer 1

Requirement 1)

Investors consider dividend as a source of income and therefore, by paying out dividends, the management of the company hopes to attract and retain investors. A possible reason for paying dividends even with lesser earnings is to exhibit company's potential for growth in the future (in the given case the company is still profitable, even though its EPS has declined). Another possible reason is that the company has been consistently profitable in previous years and has established excess cash reserves out of its earnings (in such years) which are now being used by the company to payoff dividends. Use of excess cash (already available with the company) may not trigger/indicate any negative signal in the performance of the company (even though EPS has declined) and will help the company to meet its consistent dividend policy on an year to year basis.

_____

Requirement 2)

The reason that the company might have decided to increase dividend payment in 2007/2008 even with a decrease in EPS could be to convince the investors that the company is confident of its future operations and is likely to perform better in the coming years. Any decline in dividend per share may indicate a negative expectation (on the part of company's management) about the future performance of the company. Therefore, payment of dividend even when EPS has declined can help in establishing investor confidence in the company's business and its operations.