Australian investors love dividends.
With tax-effective structures like self-managed superannuation funds (SMSFs) and the benefits of franking credits, it's little wonder why we value the income produced by shares so highly.
For example, a dividend payment of 5% fully franked is equivalent to an ordinary (unfranked) dividend of 7.14%. Together with the benefit of only 15% tax inside an SMSF, it's easy to see why many investors forgo growth potential for the yield of reputable blue-chip shares.
However, not all blue-chip dividends are created equally, and they are certainly not guaranteed to be paid each and every year. In fact, there are many reasons why a company will not pay dividends.
The most obvious reason a company withholds or reduces its dividend is due to poor financial health. It could be a cyclical setback, or long-term structural challenges, which requires the company to keep cash on its balance sheet.
3 dividend shares that could cut their payouts
Three popular Australian dividend shares are Australia and New Zealand Banking Group (ASX: ANZ), Woolworths Limited (ASX: WOW) and Rio Tinto Limited (ASX: RIO). However, for varying reasons, each of them could be expected to cut their dividends in the year ahead.
ANZ — like each of Australia's big banks — has come under pressure from APRA, the banking regulator, to strengthen its balance sheet. To do so ANZ had to issue shares to raise capital just as volatility increased throughout global markets.
Further challenges in Asia, a tougher regulatory stance and growing competition in the local banking sector present as key concerns to the bank's dividend payout moving forward.
Like ANZ, Woolworths' challenges are well known. Woolworths is Australia's largest supermarket, but Aldi and Coles appear to be cutting into its market share. Moreover, Woolworths' failed ventures in Home Improvement and discount retailing have left shareholders questioning its value proposition.
The company has committed to investing in itself and already slashed its dividend payout, while it undertakes the initiatives. Returning to the heady days of dividend growth might not be as easy as first thought.
Finally, Rio Tinto is the envy of its global mining peers. Amidst slumping commodity prices, Rio Tinto was one of only a few to uphold its dividend payout. However, the recent price drop (which may not be over just yet) serves as a reminder of the high-risk, capital-intensive nature of mining.
Indeed, dividend payments are discretionary, so shareholders' income hinges on the outlook for commodity prices. And although prices have rebounded in recent months, investors should be realistic in their growth expectations and when judging the reliability of dividend payments in the future. Analyst consensus forecasts currently point to lower distributions in the year ahead.
Foolish takeaway
Over the long-term, shares with dividends have been shown to outperform the return of shares without dividends. However, it's important to understand how dividends are paid, why they might not be paid, and to maintain a diversified portfolio.
