Along with the other banks, OCBC has recently announced the FY 2018 results. The net profit improved 11% from S$4.05b to $4.49b. Apart from its subsidiary, Great Eastern’s disappointing results, I would say that OCBC did well for FY 2018. Along with the reasonably good results, OCBC is offering a dividend of 23 cents per share for H2 FY2018, representing a dividend payout of about 41% for the whole year. This is, however, lower than its peers like DBS and UOB. The dividend payout for DBS and UOB is 56% and 50% respectively. (Click here for the performance numbers.)
Over the years, OCBC appeared to have a greater propensity to pay out scrip dividend compare to the other two banks. This is the 12th time that the bank proposed scrip dividend since the global financial crisis in 2009 . To incentivise the acceptance of scrip dividend, OCBC is offering a 10% discount on the final weighted average price from 3 May to 6 May 2019 (inclusive).
The question to many investors is – what is the purpose of the bank distributing scrip dividend? And is scrip dividend good or bad for shareholders? To me, there is no absolute advantage or disadvantage in having scrip dividends. It depends on what the bank’s objective and what we wanted as a shareholder. The financial advantage of scrip dividend is not exactly apparent. After all, one can create a quasi-scrip dividend exercise by using the cash dividend to buy the bank’s shares in the open market. The brokerage and administrative fees are comparative small in terms of costs as they can be easily offset if we purchase the bank stock at prices lower than the stock’s conversion price. That said, it is still good to discuss about the characteristics of scrip dividend from the bank’s perspective as well as from shareholder’s perspective.
For the bank
- Generally, banks (or for that matter any public-listed companies) do not like to have too much volatility in their stock prices. Essentially, they want people with long-term views. By distributing dividends in the form of scrip, it helps, to a certain extent, make shareholders hold onto their stocks longer. For one, by providing scrip dividends that end up in odd-lots in the hands of shareholders. Thus, this makes it more difficult for holders to offload their stocks easily.
- By providing a discount to the on-going share price, the bank is, in effect, encouraging shareholders to take the scrip dividend instead of cash. This helps the bank to preserve cash which can be very useful during times of need. Just base on the back-of-envelope calculation, with the dividend of 23 cents per share, it would cost the bank $979.1 million in cash for just this dividend distribution. Even though OCBC is able to meet the current Common Equity Tier 1 (CET-1) requirement, it still went ahead to offer scrip dividends. This may mean that the bank is forecasting uncertain times or it may be preserving a bigger war-chest of cash for some capital investment ahead. While attempting to preserve cash capital, it is, in effect, creating a larger share base. This will have a dilutive effect. It may work against shareholders especially when times turn for the worse. Fortunately, OCBC has been buying up their own shares in the open-market. The bank had been given the mandate in the last shareholders’ annual general meeting to buy up to 212 million (or 5% of the issued shares) in the open market. Certainly, as shareholders, we would be more comfortable with companies that are able to buy back their own shares compare those that are unable to.
- While the bank is dabbling in the stock market buying 200,000 shares each time, it is not possible to know whether the bank is gaining or losing out in this whole exercise. After all, their job is not to make a profit by buying shares in the open market. Based on the 5% buy-back mandate from the shareholders, the bank can buy up to 212 million shares. Given that OCBC makes a purchase of 200,000 shares each time, it would take more than 100 trading days to fulfill the whole order, and not including those purchasing shares under the employees’ option scheme. This translates to about 40% of the total number of trading days in a year. In some days, it may buy high and in some days it may buy low. Generally, the stock price during the conversion days tend to be very high as they are very near to the ex-dividend date. So, it means that the conversion stock price tends to be on the high side. So, even if the bank gives a 10% discount over the conversion price, there still may a chance that the bank did not lose out buying from the open market as its average buying price can be much lower than the conversion price. As of today, the conversion price is yet to be determined. It will be the weighted average of the trading share price from 3 May 2019 to 6 May 2019 (Inclusive). Note that a cash dividend is a certainty for the bank. For scrip dividend, this is not certain as to how many shares will be ultimately distributed. With the sweeteners (discounts) for shareholders thrown in, it is yet to be known whether the bank gains or loses out compare to cash dividend. However, one thing if for sure. Less cash will be dispensed, but, at the expense of a larger share base.
- As shareholders, scrip dividend can be an alternative to cash dividends if the shareholder does not need to the money at that time. The problem of going for scrip dividends it that we end up with odd lots. This can be a bit troublesome if we want to sell them in the future. Although lot size has been reduced from 1000 shares to 100 shares, stockholders are often forced to sell the mother lots in order to amalgamate the sales due to the minimum brokerage charge.
- As one may point out, there is no need to pay for brokerages and the other administrative fees when we accept scrip dividends in lieu of cash dividends. However, this often not a major issue. As it is, one can create a quasi-scrip dividend by buying the stock from the open market upon the receipt of dividends. The brokerage and all the related fees are relatively small, and can be easily offset if one is able to purchase at a lower trading price than the conversion price calculated by the bank.
- One point about scrip dividend is that we are able to practice what is known as power of compounding. Say we have 10,000 shares and the dividend rate is $0.23. Assuming a conversion rate of $11.50, we would be entitled 200 shares. The next time when OCBC declares scrip dividends, our share base would be based on 10,200 shares instead of 10,000 shares. As our stock accumulates, we are in effect, practicing the power of compounding. From that point of view, it is true. In essence, I am assuming that the future dividend distribution continues to be the same or higher. In investments, many unexpected things can happen. It is possible that the bank falls onto bad times and have to reduce the dividend rate. A decrease in the dividend rate can have a significant effect on the power of compounding.
- Certainly, a discount in the conversion price of the scrip dividend is a plus factor to encourage shareholders to take up the scrip dividend. It provides an additional margin of safety. This stands as a cushion in a falling share price situation when the global economy or the business situation for the company turns for the worse. It serves as a good alternative to getting cash dividends.
At the end of the day, there is no absolute advantage or disadvantage to either the bank or to the shareholders. It is more like a question of choice. As mentioned earlier, OCBC has the lowest payout ratio (41% compared to DBS’s 55% and UOB’s 50%.). Perhaps, it has been under pressure to bring up its dividend payout as well. Instead of increasing the dividend rate, it is probably doing so by increasing the share base so that the total payment ratio reaches the mid-40%.
Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell out of the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.
Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.