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Aspen’s dividend cut wrongfoots bond-proxy hunters

In depth
This article is part of the dossier: Investing for income

By David Whitehouse
Posted on Wednesday, 2 October 2019 14:20

REUTERS/Siphiwe Sibeko.

The case of Aspen Pharmacare, Africa’s largest pharmaceutical manufacturer which in September scrapped its dividend, is a warning to investors on the hunt for bond proxies, or shares that pay reliable dividend income.

Previous articles in our series on income investing in Africa, have considered Grit Real Estate, Anglo American and Mondi. The articles are not presented as investment advice and readers should take professional advice and/or do their own research.

The company said on September 11 the debt service payments and the need to reduce balance-sheet leveraging meant that “it would not be prudent” to pay a dividend. The company gave no indication of when it might resume payments. The last time that Aspen did not pay a dividend to shareholders was in 2009.

Developed market investors are faced with the prospect that low or negative interest rates are here to stay. That’s prompting a race to find new sources of income at reasonable levels of risk – including emerging market equites with long records of paying dividends.

Aspen illustrates how difficult that search can be.

  • “Suspending the dividend is not a usual approach to debt reduction,” says Steven Jon Kaplan, CEO of True Contrarian Investments in New Jersey.
  • “It sends a negative message.”
  • The last time Aspen omitted their dividend, Kaplan notes, was at the height of the great financial crisis. To do so now is “rather surprising – a big red flag.”

Aspen’s debt ballooned after a series of acquisitions including GlaxoSmithKline’s thrombosis drugs in 2013 and AstraZeneca’s anaesthetics portfolio in 2016. The company was able to reduce its debt by 27% in the six months to June, and predicts a further reduction in 2020.

The shares rallied on the news of the lower debt. Still, the remaining debt level of 39bn rand is “rather high – a potential warning sign,” Kaplan says.

  • He argues that the company’s ability to keep reducing the load “depends on things that are out of their control”, such as the global economic outlook.

No timetable

The company’s recent borrowings have been at higher rates and for shorter terms, Kaplan says – suggesting problems at a time when most companies are looking to lock in historically low borrowing costs for the long term.

  • In May 2018, Aspen refinanced its debt facilities with an agreement with 28 lenders for an expanded facility for 3.4b euros. The facility has lending periods of two and four years.
  • As an Aspen shareholder, Kaplan was not impressed by the “vague and brief” statement that buried the news of the dividend cut at the bottom. “It’s not intelligent PR,” he says, adding that the lack of any timetable for a resumption of dividends is also a concern.

The cut was seen by investors as a prudent move in light of the company’s debt levels, says Izak van Niekerk, investment analyst at Mergence Investment Managers in Cape Town. Debt concerns have led to a heavy market discount on the share price, so “passing the dividend to enable faster reduction of gearing levels should be more beneficial”, he says.

  • Mergence predicts that seasonality in the business may affect debt levels negatively for Aspen’s interim results, but expects the company will be successful in reducing gearing levels for 2020 and after.

Bottom Line: Large and still increasing debt loads are a warning sign that even well-established dividends may be under threat.

Also in this in Depth:

Negative interest rates highlight the case for high-yield African stocks

Bond markets around the world have slowly been facing up to the reality that low or negative interest rates are here to stay. The search is on for new ways to generate investment income with acceptable levels of risk. The Africa Report will be running a series of articles in which we analyse African shares that, for some investors, could fit the bill.

Anglo American share price weakness may create opening

Income investors are “generally not accepting “of large fluctuations in returns, says Izak van Nierkerk, an investment analyst with Mergence Investment Managers in Cape Town.

Mondi’s financial discipline offers dividend protection as paper outlook worsens

Paper and packing company Mondi fell sharply at the start of August as CEO Peter Oswald said the outlook for the company in the second half was clouded by macroeconomic uncertainty and softer demand.

South African government bonds offer refuge to investors in search of income

The latest article in our series on income investing in Africa considers the case for South African government bonds.

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