April 4, 2013 / 3:21 PM / 5 years ago

Bargain hunters scent profits from dividend cuts

* Buying and targeting dividend cuts can yield gains

* Tactic good for those who take a longer term view

* Portugal Telecom, Veolia risk future cuts -M.Stanley

By Sudip Kar-Gupta

LONDON, April 4 (Reuters) - The scale of the share price hit taken by European companies that cut their dividend is proving a boon for contrarian investors willing to take a longer-term punt on distressed targets.

Dividends have become a major attraction for those seeking alternatives to ultra-low sovereign bond yields, and companies that cut payouts - many in the telecoms, utilities and insurance sectors - have typically been heavily punished.

That panic is particularly acute when many cash-rich companies in other parts of the market are maintaining or raising their dividends, Markit data shows.

Many of the investors who sell at such a point are equity income funds, which consider dividend yield a crucial part of the stock’s attraction. Their retreat, however, leaves room for less constrained buyers to buy in at an attractive price.

“A dividend cut is usually a positive inflection point for share prices,” said Morgan Stanley equity strategist Hanyi Lim.

Lim said Morgan Stanley’s research showed that companies which cut dividends by 90 percent or more outperformed by 48 percent over the next two years.

Telecoms group BT slashed its dividend by nearly 60 percent in May 2009, sending its shares down on the day by 6.4 percent to 88.40 pence. BT shares have since trebled in value, beating a 40 percent gain in the FTSE 100 over that period.

Morgan Stanley’s research highlighted companies under pressure to cut debts and costs in the telecoms and utility sectors, where many face having to reduce the heavy debt burden taken on to finance infrastructure investment.

It singled out Portugal Telecom and utilities Veolia and Suez Environnement as among those most at risk of near-term dividend cuts.

Veolia said in February that it would step up efforts to cut its debts, and although Suez Environnement said it planned to maintain its level of dividend payout, it, too, is under pressure to reduce costs.

A fresh cut by Portugal Telecom would follow similar action last year, when it halved its dividend to help cut debt, even if it moved to partly offset any investor pain then by announcing a share buyback.

Its shares fell 3.6 percent on the day of the cut, but have since recovered 20 percent.

More recently, UK insurers RSA and Aviva have shown the value of the trade after slashing their dividends in late February and early March respectively.

Aviva fell 18 percent to an intraday low of 295 pence after its March 7 dividend cut, while RSA’s cut on Feb. 20 caused its shares to fall 14.2 percent. Both have outpaced the broader FTSE 100 since then.

Hargreaves Lansdown’s head of equities Richard Hunter said long-term investors who had swept up Aviva after its cut had made it a “recovery play overnight”.

Hartmann Capital trader Basil Petrides, meanwhile, bought Aviva on the day of the cut at between 309 and 312 pence and said he expected it to hit 400 pence over the next year.

“At these levels, they do represent good value for money. When a stock like Aviva falls between 10 and 15 percent in a day, you’ve just got to jump on it,” Petrides said. ($1 = 0.7694 euros) (Editing by Stephen Nisbet)

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