Colm Fagan article on CRH and its dividend strategy

[Brendan Burgess]

Colm Fagan has a good article in today's Sunday Times on why he sold CRH shares and is not ready to buy back in yet. We don't allow speculation about individual shares on Askaboutmoney so we can't discuss the substance of the article.

However, he raised some very valid comments about CRH's dividend strategy which merits discussion. I posted this response on the Sunday Times website , but the site just hung.

Brendan

Very interesting analysis, and first up, let me say that I am a long-term holder of CRH shares as part of a diversified portfolio of shares, and not because I have done the analysis which you have done, Colm.



"On the day it announced the higher dividend for 2008, it also asked shareholders for extra money by way of a “rights issue”. We had the peculiar situation that it was giving money to shareholders with one hand and asking for some back with the other. Why did it not bite the bullet and cut the dividend? Was it a reluctance to break with the proud tradition?"



I was particularly impressed with this, probably because it's something which I have wondered about myself. Of course, it's not only CRH which does this.Many public companies do it. And it's a disaster for the personal shareholders. We contribute new capital of €1,000 only to have it paid back to us as a dividend which is taxed at 51%. I presume that the institutional shareholders don't have this problem.

It's even worse when they do a share placing, and issue shares at a discount to institutional investors which dilutes the holdings of the existing shareholders. Then they pay the discounted cash as taxed dividends.


"The dividend is still 62.5c a share, so the dividend yield is about 2.5%. A yield this low is only acceptable if there are good prospects for dividends to grow in future. Profits for 2014 were just 78.9c a share,which is less than 30% more than the cost of the dividend. Assuming that the directors’ long-term goal is to pay 50% of profits in dividends and to reinvest the other 50%, profits will have to increase to about €1.30 a share before the dividend can be increased."



I think that this is not consistent with your earlier argument about a rights issue to fund a dividend and your correct comments that the level of debt is too high. I would much prefer if CRH broke with tradition and announced that it was going to change its dividend strategy and pay no dividends at all until it has cleared or, at least, greatly reduced its debts. If CRH is in a position to make great acquisitions during fire sales, then they can invest the money much better than I can. If I need an "income" from my shareholding, I can sell some of my shares.

After all, Warren Buffett has no debt - if fact he has a huge cash pile - and he pays no dividends.

One of the reasons companies are so reluctant to cut dividends, is that the investment community will regard it as a sign of a lack of confidence in the future. When a company cuts its dividend, the share price usually falls. But CRH could avoid this by timing the announcement of the elimination of the dividend with the next positive trading statement.

Fancy attending next year's AGM to make these points?



Brendan Burgess

 

[Colm Fagan]

One of the main reasons why companies persist in paying dividends at the same time as launching rights issues: the desire to maintain dividends for people who depend on them for an income. A point I would have liked to have made in the article, but space prevented me, is that this supposed concern for pensioners and others in need of a regular income from dividends is misguided. If people need the income from shares, they are unlikely to be able to subscribe to the rights issue. As I pointed out in the article, they lose out substantially if they decline to take up their rights. This is effective discrimination against such shareholders. The defenders of rights issues could counter that shareholders in this position could always sell their rights. I am not completely clear on the mechanics of how a private shareholder goes about selling his or her rights, but I reckon that the costs for a small shareholder would eat up most of the proceeds.

 

[Colm Fagan]

Brendan, I would also like to come back to you on your suggestion that CRH should clear down its debts before raising its dividend. I don’t agree with you on that. If a company is comfortable with its level of debt (and has supportive bondholders and bankers) and is confident that it can generate the profits to service the debt, then shareholders can actually do far better than if the company is unleveraged. In fact, my major complaint with Renishaw, the subject of last month’s column, is that it is far too preoccupied with having no debt and owning so many of its properties. One could justifiably argue that shareholders in that company would be far better off if it grew its business aggressively by expanding much faster into areas where it has obvious expertise, and forgetting about building up cash piles and deciding to rent rather than buy properties around the world. It doesn't have great expertise in property management: it does have that expertise in 3-D printing, metrology, and specialist healthcare equipment.

 

[Duke of Marmalade]

Interesting discussion.

Boss you point out the very obvious conflicts with the individual investor's tax position, but these are always present. Carried to extreme, this argument would hold that companies should never pay dividends but should buy back shares instead. In fact scrips used be taxed as capital and not income but this anomaly was removed some time ago. I suppose if the profits were still sufficient to cover the dividends but the company decided to retain these for investment purposes there could be a whiff of tax avoidance.

For the ordinary punter, it is possible to neutralise a rights issue by selling enough rights to fund the taking up of the residual.

I agree with Colm that debt has a beneficial role in corporate structures. For individuals I subscribe to the view that you should pay down debt if you can but for companies there will be an optimal (for the shareholders) financing structure which will usually include debt.

 

[Brendan Burgess]

Sorry guys, I worded that badly. I have no objection to debt at all. But in the past few years, strong companies had great opportunities to snap up bargains during forced sales. CRH has a high level of debt today, as you point out in your article Colm. This reduces its ability to take advantage of bargains. I think it should greatly reduce its debt by passing on dividends for a while.

Brendan

 

[Brendan Burgess]

The defenders of rights issues could counter that shareholders in this position could always sell their rights. I am not completely clear on the mechanics of how a private shareholder goes about selling his or her rights, but I reckon that the costs for a small shareholder would eat up most of the proceeds.

I think I have sold rights once and it was fine. One can sell them on the stock exchange or one can let the company do it for you. There are transaction costs, but they are proportionate.

If CRH needed to raise a large amount tomorrow to fund an acquisition, it wouldn't worry me unduly if I hadn't the cash. I would prefer if they raised less and cancelled the dividend.

Brendan