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Tesco: should it pay a dividend when it expects government support?

The final dividend declared today amounts to £636.5mln, while the grocery group expects a £585mln benefit from the government's business rates holiday for the retail sector - but is it quite so simple as that?

Tesco PLC -

Tesco PLC (LON:TSCO) on Wednesday set out the case, in a way, why it should receive government support and also pay a dividend to shareholders amid the coronavirus crisis. 

A debate has already been raging over whether it is right for companies to pay a dividend when they have been supported by the government.

Easyjet (LON:EZJ), for example, put thousands of staff on ‘furlough’ under the government job retention scheme and more recently was given a £600mln coronavirus loan, but all this just days after paying out a £174mln dividend.

There has also been a debate about whether some companies should accept government support at all, as seen at Liverpool FC.

As for Tesco, one other retail boss recently told a national newspaper that Tesco “should hand the money back to the NHS”.

READ: Tesco warns coronavirus shopping boost will be "largely offset" by extra costs

But the argument about Tesco was simple for analysts at city broker Shore Capital, noting that the company “is paying VAT, has furloughed no one and is not participating in government financing schemes”.

However, the supermarket group is expecting extra government support in the shape of 12 months of business rates relief offered to the whole UK retail sector, which it revealed was expected to be roughly £585mln.

And as part of its results on Wednesday, Tesco declared that it will pay a final dividend of 6.5p for the past year.

With 9,793mln shares in issue this equates to a payout of £636.5mln, with the previous 2019/20 interim dividend taking the a total dividend to 9.15p per share or a grand total of £896mln. 

What’s more Tesco with plans to return around £5bn, or around 51p per share payout, of the proceeds from its US$10.7bn (£8.2bn) Thai and Malaysian disposal, which it expects to complete in the second half.

Witness statement

In Tesco’s results, the giant grocer set out its position, with CEO Dave Lewis noting how “COVID-19 has shown how critical the food supply chain is to the UK”, highlighting that the industry’s important role in “feeding the nation”.

Lewis said this brought “significant extra costs” and that these are only “partially offset” by the UK business rates relief.

If customer behaviour is able to return to normal by August he said is likely that potential additional costs of roughly £650-925mln incurred in retail operations would be “largely offset” the business rates, plus the benefits of food volume increases and “prudent operations management”.

Or, in other words, without the government support, Tesco, which has around £12bn of net debt, would be around £585mln in the red for the coming year.

Lewis also told reporters the payout “is reflective of last year’s performance and the strength of the business”, as the board decided  that even in the most stressed scenario it would not require more liquidity.

With Tesco having not paid a dividend for the five years after Lewis was appointed in the wake of the discovery of a £263mln accounting black hole, he said the payout was a fair reward to shareholders who “supported the business through its turnaround”.

Case for the defence

“Tesco is getting a slightly unfair rap,” says Richard Hunter, noting that the company has free cash flow of some £2bn and has significantly reduced its net debt over the last five years or so.

“Its robust balance sheet means that the dividend is affordable.”

Over at Bernstein, analysts were even slightly disappointed at “no mentions on the possibility of buybacks which we are expecting this year”, but acknowledged that this was “understandable given the context... just a matter of time”.

Further defending Tesco, Hunter pointed to the ESG measures the FTSE 100 group has put in place during the coronavirus outbreak.

These included a 10% bonus on the hourly rate for staff in stores, distribution centres, customer engagement centres and front-line store managers, plus increased donations to local community organisations and charities, including £15mln of food donations to food bank charities, plus £2mln of cash donations.

“The costs it is incurring far outweigh the business relief rates holiday,” Hunter says. “From a purely financial perspective, the company is therefore not profiting from the business relief.”

New normal coming for dividends?

Tesco’s case for paying out is “strengthened” as the company is not straining its finances and staff are major shareholders, especially those beyond the boardroom, said Russ Mould, investment director at AJ Bell.

More generally, with four insurance giants taking the total to £19.3bn of dividends cancelled or postponed so far in 2020, he said the combination of regulatory intervention and greater public awareness of the issue of dividend payments is a “new, variable element for equity investors and income-seekers to address”. 

“Whatever the length of the COVID-19 lockdown and the duration of the subsequent economic downturn, this debate may be one of their longest-lasting effects,” said Mould.

He said the increased public appreciation of those who have worked in stores or warehouses or supply chains and kept the show on the road could also mean increased pressure for not just supermarkets to improve salaries and conditions for their lower-paid staff.

“Increased government involvement could mean more regulation and greater emphasis upon returns for stakeholders (employees) relative to shareholders.

“This combination could all mean lower returns on capital, lower pay-outs an potentially lower trend total returns for investors. 

“Share buybacks in particular will surely come in for greater regulatory scrutiny but dividends could be restrained too, either voluntarily by companies or otherwise. This could knock, to some degree, the long-term investment case for equities, since dividends are a vital component in the total return from stocks.”

Quick facts: Tesco PLC

Price: 231.1 GBX

LSE:TSCO
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Market Cap: £22.63 billion
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