How will shareholders react to Morrison’s plans to axe dividend pay-outs?

How will shareholders react to Morrison’s plans to axe dividend pay-outs?

After years of sticking to their commitment of steadily increasing dividend pay-outs, Morrison’s is set to heavily cut dividend once the final promised pay-out is completed at the end of the 2014-2015 financial year. What this situation highlights is the issue of what priorities businesses should take in terms of dividend pay outs, and what is the most important? Is it shareholder wealth or should the company itself that should take precedence?

The 2014-2015 financial year has not been kind to Morrison. The introduction of the discount supermarkets has seen the company having to slash prices in order to remain competitive. This in turn has resulted in a pre-tax profit fall from£785m last year to £342m this year (Ruddick, 2015). As a result of this performance drop the company has deemed it necessary to invest earnings into addressing the issue of the discount supermarkets instead of paying out the high levels of dividends it has done in the past. Dividend is set to be cut by 44-60% of the current figure (Felsted, 2015), which will greatly disappoint any institutional investors that rely on a constant stream of pay-outs and obviously prefer them to remain high.

However the argument of dividend relevance or irrelevance is at the forefront of this discussion. Changing to a fixed rate dividend policy that is estimated to be one third to half of earnings is a far more sustainable dividend policy, compared to the current steadily increasing dividend policy,  as it allows the company to utilise the rest of the retained earnings to invest in the future of the company. It also will help the business maintain a healthier liquidity ratio as dividend pay-outs are cash transactions and should not be associated with profit performance of the business. (Arnold, 2013, p. 326). Investing in the future of the business is a more sustainable approach and incorporating a dividend policy into that with a fixed rate pay-out will ensure long term investor satisfaction through consistent dividend returns that are not detrimental to the company. 

The issue with this situation is how the investors will react to their dividend being cut. Now at first glance investors should be disappointed with this decision. However when analysing the business’s performance alongside future prospects, investors should realise that in order for them to receive sustainable long term returns from the company, investment needs to be made into the business and the best way to do that, in this situation, is through cutting dividends. In addition dividend irrelevance theory and additional empirical studies have shown that dividends does not affect the share price (Arnold, 2013), what has a more drastic effect on shares, is the performance of the business and without reinvestment of equity into the business, that performance will fall and share price will plummet which in turn would upset/cost investors significantly.

References

Arnold, G. (2013). Corporate financial management. Harlow : Pearson.

Felsted, A. (2015, March 02). Morrison poised to take axe to dividend. Retrieved March 18, 2015, from Financial Times: http://www.ft.com/cms/s/0/62dc2054-c0ff-11e4-876d-00144feab7de.html#axzz3aP02brml

Ruddick, G. (2015, March 7). Morrisons to slash dividend to fund rescue plan. Retrieved March 18, 2015, from The Telegraph : http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11455839/Morrisons-to-slash-dividend-to-fund-rescue-plan.html