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Why the share market is loving NAB’s dividend cut

Our ‘Big Four’ banks were all (at least until recently) loved by investors for many years for delivering some of the biggest, steadiest fully-franked yields on the ASX. Normal ASX share market behaviour would indicate that if one said bank were to cut its dividend by 16%, the immediate result might be a big drop in share price, if not downright revolution.

This is exactly what the National Australia Bank Ltd. (ASX: NAB) did on May 1, cutting its interim dividend from 99 cents per share to 83 cents. Most investors had been expecting a cut, as NAB’s payout ratio was without question a bit on the high side, but the 16% cut took most (including this writer) by surprise. Markets generally don’t respond well to dividend-cuts at the best of times and when yields are cut beyond expectations… it usually ends badly.

However, investors seemed to whole-heartedly endorse (and almost celebrate) NAB’s new-found frugality. NAB shares were up over 3% in the week following the announcement and have only pulled back this week as markets were weighed down by the trade-war tension. This was unusual, as the market often trims the share price in order to maintain a similar yield ratio when a dividend is cut. Anyone who has owned shares of Telstra Corporation Ltd (ASX: TLS) for a while would know this very well.

So why was NAB’s dividend cut celebrated?

I think NAB investors responded positively to the frankness of new chief Phil Chronican surrounding the cut and the need for ongoing customer remediation in light of the Royal Commission scandals. Companies can get in a lot of financial trouble if they pay dividends they can’t afford and the market clearly feels that NAB has turned down the spigot at the right moment.

It also pays to remember that NAB’s previous dividend yielded a whopping 11% (including franking). Even with this cut (and assuming the same 86 cents per share in the full-year dividend), NAB’s yield will still be around 9%, which still beats the pants off most other dividend-paying blue-chips. So although the glory days of 11% yields may be over, investors are evidently feeling consoled by the more-sustainable 9% yield going forward.

Another thing to keep in mind is that NAB is going ex-dividend on May 14, so its share price is likely being buoyed by this as well. Maybe we’ll have to wait until May 15 to find out what the market really thinks. But it seems pretty clear right now in my opinion.

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Motley Fool contributor Sebastian Bowen owns shares of National Australia Bank Limited and Telstra Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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