European CEOs should avoid starving capex for divis

August 13, 2013

By Robert Cole

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Corporate Europe is struggling to grow earnings as fast as it has been raising dividends. That could lead to a squeeze, and some tricky decisions about how companies use their cash.

Larger European companies will on average raise earnings by 0.03 percent in 2013 with only four of ten sectors – led by financials and information-technology stocks – in positive territory, according to Standard & Poor’s. Quoted companies will raise their dividends at a compound annual rate of 8.3 percent over the next three years, Morgan Stanley predicts.

That won’t matter if Europe’s economic gloom continues to lift and revenue picks up. But temporary strain does exist. Dividend payout ratios are just over 44 percent of European corporate earnings, up from 37 percent in December 2010, according to Thomson Reuters Datastream. The ratio has also been rising in the United States. Still, at 37 percent now, up from 30 percent 18 months ago, shareholder payouts look more affordable.

Rises in financing costs that accompany recent increases in benchmark bond rates create further earnings pressure. Cost cutting might help, but after having endured five or more lean years already it will be hard for companies to drive efficiency gains.

The risk is that companies cut investment to protect treasured income-growth records. A survey from S&P indicates that capex in western Europe is down 8 percent compared to 2008. Energy companies account for about half of all capex, according to S&P, and they are feeling special pressure as commodity prices soften. The temptation to skimp on investment to bolster dividends is one any CEO can feel – especially when the low-interest-rate environment has seen investors reward companies that provide income.

Dividend commitments provide a useful straitjacket that forces management to be disciplined in their capital expenditure. But while cuts to capex help sustain dividend growth in the short term, they do the opposite in the longer term. In weak economies, companies have to work harder – and invest harder – to secure success. Investors should be tolerant of those that sacrifice dividend growth today to invest in the progressive dividends of the future.

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