In a release at the end of November that would not typically start hearts racing, Royal Dutch Shell announced that it was cancelling the option for shareholders to take a scrip dividend in preference to cash. With scrips, the shares are newly issued and consequently the issuer raises money in the process with the exercise acting as a mini rights issue. While there are some fluffy justifications made by companies which run scrip dividend programmes (e.g. the investor accepting the scrip offer purchases shares without incurring transaction costs) the clear message is that the company needs the cash, but is unwilling to cut the dividend.
Scrips also inform us that a company does not guard its shares preciously – in stark contrast to Warren Buffett who, “… would rather prepare for a colonoscopy than issue Berkshire shares” – and therefore marks them down in terms of their capital allocation skills. Over a long period, the share issuance resulting from scrips can be reasonably significant. For example, when Aviva removed the scrip alternative in 2013, management informed the market that the scrip had created earnings dilution of 16% over the previous eight years. An expensive price to pay for a company trying to pretend to investors that a high dividend was affordable.
As often happens there are some perverse incentives at work here. The company’s advisors probably fear that if they suggest a dividend cut, the share price of their client will fall (and thus they adopt a strategy of advising the delay of any bad news). Similarly, company management often feels its reputation will be adversely affected by a cut and a board may feel it is implying that the outlook for the company has deteriorated.
We would much prefer more honesty and less delusional behaviour. In the last month, we have been hit by a profits warning from Centrica, a company which is clearly struggling in a number of areas and whose balance sheet is less than copper-bottomed. The company conducted a surprise share placing less than 18 months ago, but despite that continues to shore up its dividend with a scrip. The investment decision was mine so clearly I am at fault, but in this instance, I have not been aided by a management team which apparently refuses to face up to its cashflow difficulties.