Dividend cut may be a blessing in disguise for M&S

NEWS ANALYSIS If Marks & Spencer bites the bullet and reduces returns to shareholders it will be in distinguished company; other blue chips suffered the same humiliation, to come back in fighting form

IS MARKS & SPENCER about to become the latest blue chip company to cut its dividend? Dividend cuts tend to be seen as an admission by the board that the company has hit crisis point, needs to regroup and adjust its payout accordingly. And because of the negative impact on market sentiment and staff morale, the move tends to be viewed as the action of last resort.

But it may not be the shaming experience it may first appear. Indeed the list of companies that have taken this route reads like a roll call of our bluest of blue chip companies. They include ICI, Barclays Bank, BP, British Aerospace and British Steel.

For the most part these dividend cuts came to be viewed in retrospect as positive moves in the longer term development of the businesses. BP is one example. Its shares have risen sixfold since Sir Bob Horton's successor, David Simons, took the axe to the dividend in 1992 to help reduce the group's $16bn debt burden. BAe and Barclays have enjoyed similar experiences.

It is by no means clear whether M&S is prepared to bite the bullet. When it reported a halving of interim profits on Tuesday the company's finance director, Robert Colvill, refused to rule out a cut in the final dividend next May. He admitted that the final payout, like the interim one, was likely to be uncovered by earnings and would have to be paid from reserves. But he pointed to the relatively ungeared balance sheet as a means by which M&S could continue to support its dividend through debt. But with the dividend still based on the pounds 1bn of annual profits achieved in 1997 - a figure the company is unlikely to achieve again in the short term - a cut would seem prudent.

The M&S board may not be sure which way it should jump, but the market is. One senior City fund manager said yesterday: "Will it cut its dividend? I'm sure it will. But it may not quite have reached the maximum point of misery yet. It needs a new board, a cut in the dividend and a move out of its Baker Street head office which is a cultural albatross. Then they might start to tackle the problems."

A retail analyst who preferred not to be named said: "To be honest they looked a bit silly not cutting it on Tuesday."

Equity strategists say dividend cuts send very clear messages to the markets and so the timing needs to be right and the cut accompanied by a plausible recovery strategy. If these elements are in place, then it is sensible to get the bad news out of the way and start to rebuild.

Richard Jeffries, group economist at CCF Charterhouse, says: "When you have a general downturn in the economy then it can be sensible to have an adjustment if a quick bounce in profits is not foreseen. But it does send a very clear signal. M&S has been trying to reassure people that it can engineer a recovery. It if cuts the dividend it shows they may have some doubts."

Another institutional fund manager says: "The history of cutting dividends is that as long as it looks like a company is bent on reform and recovery then it will be accepted."

BP is one example. In 1982 the business was in a mess due to a heavy investment programme during the recession which dragged on longer than expected. Debts soared to $16bn and the unpopular chairman, Sir Bob Horton, was replaced by David Simons.

The new man cut the payout and though the shares sank initially, the decision marked a turning point. BP shares, now under the BP Amoco name following the merger, have soared.

British Aerospace is another example. In 1991-92 the company was hammered by a slump in aircraft demand following the Gulf War. A pounds 1bn write-off wiped out the group's reserves and a dividend cut became inevitable.

Again it marked a turning point. "It forced people to grasp the problems," a spokesman said. BAe closed down a large part of its commercial aircraft operations and began a steady improvement.

Barclays cut its dividend in 1992 after slumping to a pounds 242m loss. The slump was caused by pounds 2.5bn of bad debt provisions after a lending binge in the late 1980s started to unravel. Barclays had already paid an uncovered dividend two years running and finally admitted the game was up. The market was shocked as Barclays had given the impression that the dividend was secure. But even though the bank has hardly been a consistent performer in recent years its shares are within 10 per cent of their all time high.

British Sky Broadcasting is a classic example of how a dividend cut can be fully supported if the market feels the board has a plausible strategy. BSkyB cut its dividend in May this year to help fund the decision to give away free set-top boxes for digital television. The City accepted Sky's view that the digital battle was of vital strategic importance and marked the shares up 12 per cent on the day. They have continued to be strong since.

Not all cuts are forgiven however. The key example is ICI which cut its dividend in 1982 after the group's profits were ravaged by the combination of the recession and the strong pound. The market never forgave the company when the economy started to recover soon after, making the cut, in the City's view, unnecessary.

But not all cuts mark the start of a corporate renaissance either. United Biscuits cut its dividend in 1995 after its disastrous international expansion plan collapsed. But the cut marked the start of a long-term decline rather than the green shoots of recovery. The company was ousted from the FTSE 100 and is now facing a takeover.

According to Richard Jeffries at Charterhouse, Britain's problem may be that it bases its underlying dividend payments too high, bumping the payment up during the good times but then reluctant to cut when the economic cycle turns. His view is that it would be better to follow the United States model where base dividends are lower but special dividends and share buy-backs are far more common.

At the moment, Marks & Spencer looks like it is trying to do both, a position it may find is untenable.

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