The economic catastrophe that the coronavirus has inflicted upon our economy is going to have massive consequences for almost every business in Australia.
The fact that the S&P/ASX 200 Index (ASX: XJO) has fallen around 27% compared to the pre-crash highs merely reflects this reality in my opinion.
With businesses going into hibernation and Australians being forced to stay indoors, the question many dividend investors are now starting to ask is simple: are my ASX income shares going to cut their dividends in 2020 – and if so, by how much?
When does a company have to cut its dividend?
Dividends are cash payments distributed to shareholders from the pool of earnings (or profits) a company makes. A business receives revenue from sales, deducts expenses and is then left with a pile of cash. The company can then choose to allocate cash to expanding the business, pay tax or pay this cash out as a dividend, or both to varying degrees.
But unfortunately, most companies' costs are a lot more fixed and inflexible than its revenues. And if revenues quickly dry up, then all of a sudden, the company doesn't have too much cash to payout.
If this is the case, then the dividend is immediately in danger.
Sure, the company can borrow money, raise capital, use its own savings (if it has any) or sell assets in order to temporarily fund this dividend. But this is unsustainable and will sooner or later result in a dividend cut if the situation isn't rectified quickly.
Will ASX shares be forced to cut their payouts in 2020?
Unfortunately, it's a live possibility that many ASX companies won't be able to afford to continue their previous level of cash payments in 2020. Reporting in the Financial Times suggests that companies over in the US will struggle to return to 2019's payment levels for up to 9 years! And US companies typically pay out less of their earnings than ASX companies due to their lack of a franking credit system.
This doesn't bode well for established ASX dividend payers. Already this year, we have heard from ASX shares like Transurban Group Ltd (ASX: TCL) who have withdrawn their previous dividend guidance and adopted a 'let's wait and see' outlook for the time being.
And its almost certain that the market is pricing in large dividend cuts from the ASX banks like National Australia Bank Ltd (ASX: NAB) – which has a grossed-up trailing yield of 14.7%.
Foolish takeaway
For now, we'll have to wait and see who comes out of this ASX bear market with their dividend intact – and who doesn't. It's a trying time for the economy and the companies that work within it.
Dividends are the product of a healthy business and so it's hard to expect these to continue when large parts of the economy are in hibernation. Investors should always be ready for anything, and this crisis has proved that in the most brutal of ways.
