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The next ASX sector at risk of cutting dividends

Investors are still licking their wounds from the dramatic big bank dividend cuts, but there’s another sector that’s at dividend risk.

The decision to slice or skip these precious payouts is a big reason why banks like the Australia and New Zealand Banking GrpLtd (ASX: ANZ) share price and Westpac Banking Corp (ASX: WBC) share price are still well below their pre-COVID-19 levels.

While the worst of the pandemic appears to be behind us, it will be awhile before the big banks can fully restore their dividends.

Income investors beware

There’s another group of dividend disappointers that are likely to reveal themselves during the August profit reporting season – and that’s property trusts.

Property stocks are a favourite among income-seeking investors and Morgan Stanley warns that the payout ratios in this sector may need to be cut.

Falling rents will not only pressure earnings, but are likely to force some to write down the value of these assets.

Properties under pressure

“On a 6- to 18-month view, asset values in Retail property, and Office to a lesser extent, will be subject to downward pressure as rent structures get reviewed, and office vacancies increase,” said Morgan Stanley.

“This means the gearing of these companies is likely to escalate, holding all else constant.”

This means property stocks may need to hold on to more cash to shore up their balance sheets and give themselves more flexibility.

Stocks most at risk

That will come at the expense of dividends with the broker estimating that a 15% drop in asset values could prompt most in the sector to lower their payout ratios to 50%.

It’s those most exposed to retail properties that are the most likely to cut their distributions. These include Scentre Group (ASX: SCG), Vicinity Centres (ASX: VCX) and Stockland Corporation Ltd (ASX: SGP), according to Morgan Stanley.

A 15% drop in property value will drive Vicinity’s gearing up to around 32% from 27%, while Stockland’s gearing is already near the top of management’s target 20% to 30% range.

Falling yields

“Lowering payout ratios to 50% would mean SCG, VCX and SGP’s FY21e yields decline to 3.9%,3.3%, and 4.2% respectively,” said the broker.

“[This is] well below the 5-6% the market has become accustomed to. At headline level, this is not a positive.”

However, Morgan Stanley thinks the market will forgive a dividend cut if it’s used as a temporary (maybe up to two years) measure to strengthen balance sheets.

This is especially so if it means the companies do not need to undertake a capital raising.

Not good enough

In my view, this makes the sector rather unappealing. Not only are the yields low even in this low interest rate environment, but there’s the added uncertainty from looming structural changes for both malls and offices.

I think there are better value stocks to be targeting in this market. If you are looking for other options, the experts at the Motley Fool have picked their best ASX stocks for the post-coronavirus world.

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Motley Fool contributor BrenLau owns shares of Australia & New Zealand Banking Group Limited and Westpac Banking. The Motley Fool Australia has recommended Scentre Group. 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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