Are dividend cuts inevitable for HSBC Holdings plc, Persimmon plc and Taylor Wimpey plc?

Having benefitted from the sharp fall in the value of the pound following the Brexit vote, shares in HSBC (LSE: HSBA) are up 7% since the EU referendum on 23 June. HSBC’s London-listed shares have outperformed much of the sector because the bank’s dollar earnings are now worth more in sterling terms. Unfortunately though, sterling’s current weakness doesn’t bode well for its dividend sustainability.

As HSBC declares its dividends in dollars, the bank’s dividend payout ratio doesn’t benefit from the improved sterling earnings translation of its foreign income. On the contrary, a weak pound would lower its payout ratio, as income from its UK businesses would be worth less in dollar terms. And that’s before we consider weaker profitability from the UK, even in sterling terms, from a slowing domestic economy and lower investment banking revenues following Brexit.

The ability to maintain dividend payouts ultimately depends on the bank’s profitability. And even before the Brexit vote, HSBC’s dividend payout ratio had been under a lot of pressure. Its dividend cover stood at just 1.3 times last year, down from 1.4 times in 2014 and 1.7 times in 2013. With few positive catalysts on the horizon, HSBC’s dividend sustainability doesn’t look good.

The pound’s weakness does have a benefit for UK dividend investors though – the value of its annual dividend of $0.51 per share is worth more in sterling terms now. This means that assuming HSBC can maintain its dividend at 2015 levels and sterling’s current weakness persists, shares in HSBC trade at a very temping prospective yield of 8.2%.

Absolute dividend policies

Until recently, Taylor Wimpey (LSE: TW) and Persimmon (LSE: PSN) were two dividend growth darlings. Income investors flocked to them because of their rapidly growing dividend yields and low valuation multiples. Right now, everyone is worried that dividend cuts are inevitable.

But there’s no real risk of dividend cuts in the short term. Both housebuilders have very strong cash balances and very little debt on their balance sheets. Both companies also have absolute dividend policies based on excess capital on their balance sheets rather than pegged to future earnings.

A dividend cut in the longer term may not be inevitable either. While investor demand in the commercial property sector has taken a very big hit, the residential market is quite different. Long-term fundamentals are better for the residential market because there remains a chronic housing shortage. The number of new houses being built remains well below their pre-recession highs, and that’s unlikely to change any time soon.

Housebuilders can also do more to conserve cash and prioritise dividends by reducing investment in land banks, delaying new construction and cutting back on share repurchases. Taylor Wimpey and Persimmon already have very large strategic landbanks, with both companies having around six years of supply at current build rates. What’s more, Taylor Wimpey and Persimmon’s 20%-plus margins mean they can withstand a modest house price shock and remain very profitable.

For 2016, shares in Taylor Wimpey have a prospective dividend yield of 7.8%, while Persimmon’s shares yield 7.3%.

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Jack Tang has a position in Taylor Wimpey plc. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.