The big dividend cut by National Australia Bank Ltd. (ASX: NAB) puts the spotlight on the big risks facing income investors during the COVID-19 crisis.
You can bet we have not seen the end of the dividend downgrade cycle and that will weigh on the S&P/ASX 200 Index (Index:^AXJO).
But there are some cases where the reduction, or even suspension, of these precious regular distributions could trigger a rally in the share price of the company in question!
Dividend sin
That might sound like a crazy notion and I need to qualify this by saying this won't happen in most cases.
The fact is, cutting or suspending a dividend is seen as a cardinal sin on the market, and it isn't only because it lowers the returns for shareholders.
Such a move also signals management's lack of confidence in the company's outlook. What also hurts sentiment is that a dividend cut is usually not a temporary affair. From my experience, it takes years before a reduction/suspension is unwound and dividends return to pre-cut levels.
Dividend de-rating risk
This is why stocks that commit such an act are often de-rated (or rebased if you want to use a kinder word). If the market believes that an ASX stock needs to generate a minimum yield and management lowers the dividend to below that level, the share price will rebase lower.
This is to return the yield to that minimum level as price and yield move in opposite directions.
When a downgrade becomes an upgrade
But there are exceptions, especially during these anxious times.
This applies to ASX growth shares that pay a dividend. In many cases, investors don't really care about the dividend as it's a very small component of their total return expectations for the investment.
There's another qualification. There needs to be questions about whether this growth stock needs an extra cash injection to keep growing its business.
Capital raising cloud
At this time, unless the company recently completed a capital raise or is one of the iron ore producers like Rio Tino Limited (ASX: RIO) and BHP Group Ltd (ASX: BHP), there will be a capital raising cloud hanging overhead.
These are uncertain times and no one can quite quantify the financial impact from the unfolding coronavirus pandemic. Having a good amount of cash in the bank isn't enough to keep capital raising doubts at bay. The company needs a big cash buffer too, just like the mining giants.
The stock to buck the dividend trend
One stock that may benefit from a dividend cut is James Hardie Industries plc (ASX: JHX). JP Morgan put the building materials supplier on its "Top Ideas" list of best buys but noted that it's balance sheet looks a little "full".
The broker is suggesting that management should skip paying the final FY20 dividend and as it believes investors won't be disappointed by such a move.
As a shareholder, I couldn't agree more. I didn't buy the stock for its paltry dividend that works out to around a 2% yield. I don't think I would be alone when I say I rather forgo dividends if it means James Hardie won't need to do a cap raise.
If cancelling the dividend removes the risk of a new share offer, I believe the stock could jump!
