Saturday 14 March 2015

Dividend Policy Issues


In the summer of 2014, Tesco unexpectedly announced that they would be cutting their interim dividend by a huge 75 percent, and reducing their capital investments by 16 percent (Thesing, 2014). This news came just a week before their new CEO was due to start. Their new CEO, Dave Lewis, former veteran at Unilever will take charge with no real experience of working in the supermarket sector. The fact that they have appointed a marketing man, rather than an experienced chief displays the great deal of alarm shareholders have over the declining supermarket (Rankin, 2014). Their idea behind the reduced dividend is to give Lewis more firepower to turn around the chain.   

 
Of course, with Tesco losing their market share following the financial crisis you would easily assume that they would be reducing dividend payments with profit margins down. However the scale of the reduction in dividend payments is likely to further alarm shareholders, but they need to be aware that it will take time to reverse their underperformance of the past 3 years (Burgess, 2014).

 
So why did Tesco opt to reduce its dividends on such a great scale. Besides giving more firepower to new CEO (as mentioned above), does this lead to the acknowledgement that Tesco’s overall company valuation has declined significantly? Not if you acknowledge Modigliani and Miller’s (M & M) 1963 argument concerning their dividend irrelevance theory. M & M proposed that, in a perfect capital market with no taxation or related costs, the valuation of a company is not affected by the dividend payments. Their argument implies that when a company has no new investments to undertake, that the funds that would have went to investments should go to shareholders (Drake and Fabozzi, 2010: p143). In 2015, Tesco’s cash reserves fell by £648 million, showing an increased debt to equity ratio (Financial Times, 2015).

 
Tesco, have opted to ignore the above argument, and have used cash that would have went to shareholder’s dividends to turn the business around. This ignores the clientele effect where shareholders have a need for regular dividend payments, and should not be different to the dividend policies. This could lead to a negative clientele effect where shareholders opt to sell some of their shares to meet liabilities (Petty et al, 2011). This could come at a cost to Tesco’s shareholders as they may have to sell shares at a cheaper rate to cover their liabilities, as well as the process being time-consuming and implying transaction costs.   

 
Tesco have to consider whether this could be an ongoing trend for the near future, and if so consider the backlash they would receive as shareholders will be, in the short term, losing out on payments that they should have received. If their new CEO’s turnaround plans don’t pay off within the short to medium term then their shareholders could attack him (verbally) at the AGM, which was the case two years ago when they criticised then CEO Phillip Clarke for failing to stem losses (Neate, 2012).

 
In my opinion, I think that Tesco are making a wise decision, although it is to the dismay of their shareholders. As shareholders they should know how difficult the market has been and consider the supermarket price wars, as well as the rise of the bargain-based retailers such as Aldi and Lidl. With a new CEO with no experience working in the supermarket sector, you can understand shareholder worries but I think this could be just what Tesco needs. A fresh perspective on the company could bring ideas that were before not realised, and with the CEO’s successful past with Unilever they know that he has a good track record. I was surprised to see the 75 percent reduction in the interim dividend but this could well be a one off dilemma, and normal payments could preside in the flowing 6 months. All in all, Tesco has a difficult task of restoring the supermarkets past glory, and by investing in new ideas and with a new chief at the helm they could well do so if they adopt new strategies and consider consumer shopping habits in the future.    

 

 
Reference List

 
Burgess, K. (2014). Tesco’s shareholders must wait to feel the love. Retrieved from: http://www.ft.com/cms/s/0/23919e2c-10e9-11e4-b116-00144feabdc0.html#axzz3ZZJn8kia

Drake, P, P., Fabozzi, F, J. (2010). The Basics of Finance: An introduction to Financial Markets, Business Finance, and Portfolio Management. New Jersey: John Wiley & Sons Inc.

Financial Times (2015). Tesco PLC. Retrieved from: http://markets.ft.com/research/Markets/Tearsheets/Financials?s=TSCO:LSE

Neate, R. (2012). Tesco shareholders attack Phillip Clarke at AGM. Retrieved from: http://www.theguardian.com/business/2012/jun/29/tesco-shareholders-philip-clarke-agm

Petty, J, W., Titman, S., Keown, A, J., Martin, P., Martin, J, D., Burrow, M., Nguyen, H. (2011).  Financial Management: Principles and Applications, 6th Edition. New South Wales: Pearson Higher Education.

Rankin, J. (2014). New Tesco CEO Dave Lewis – profile. Retrieved from: http://www.theguardian.com/business/2014/jul/21/new-tesco-ceo-dave-lewis-profile

Thesing, G. (2014). Tesco Slumps as Retailer Slashes Dividend 75% on forecast. Retrieved from: http://www.bloomberg.com/news/articles/2014-08-29/tesco-says-full-year-profit-will-fall-cuts-interim-dividend

 

 

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