Dividend Forecasting - Tariff Impacts on sectors & dividends

This year's first earnings season began with discussions around the potential implications of tariffs. Several large companies emphasized during their earnings calls that tariffs are not new to them. The dividend-paying companies featured in our annual report addressed tariff concerns by noting that they have already diversified their supply chains and localized production. Some companies are hoping to pass the cost increase to consumers. Nevertheless, the depth and potential long-term impact of tariffs should not be overlooked, as it remains to be seen how companies will readjust—and which ones may struggle to survive in the long run.

With recent reciprocal tariff announcements and postponements, the market expects a global response that will shape near-future macroeconomic effects. What does this mean for dividends? In general, companies with a strong commitment to dividends—especially those focused on consistent annual dividend growth—may still increase payouts, but at a more modest pace. For instance, companies that initiated dividends last year, such as Meta Platforms, Inc. or Salesforce, Inc., have increased their dividends as expected, though the increase was more conservative towards our bear-case scenario.

Companies historically known for holding back dividend increases during market downturns might follow the same approach this year. Smaller companies that struggle with generating healthy cash flow might decide to preserve their balance sheets and reduce their discretionary cash flow spending, including dividends. With share prices down, dividend-paying companies could also consider maximizing their capital allocation strategies by directing committed returns through share buybacks.

The impact of tariffs varies by sector, making either a direct or indirect impact:

Oil and Gas
While the scope of tariffs implies the largest market uncertainty for this year, leadership in energy companies is more concerned not so much about direct tariffs' impact on oil and gas production, but rather how tariffs would shape global economic growth.

While oil and gas are exempt from Trump's tariffs, the oil price has fallen to a four-year low, and energy companies' share prices declined at the beginning of this week. Tariffs are driving fears of a recession, as business activities are expected to slow down, which could lead to lower demand for oil. At the same time, the risk of oversupply is looming, with the disproportion between supply and demand further weakening crude prices.

Whether it's the impact of tariffs, rising inflation, or elevated interest rates, major players in oil and gas companies appear well-positioned for a potential down cycle, having built strong balance sheets and maintained investment-grade credit ratings. On the operational side, the wave of consolidation observed in upstream and integrated companies toward the end of 2023 and into 2024 has driven down costs, enabling these firms to preserve competitive margins.

Banks
As the fear of recession gears up since the tariffs were declared, the risks to US banks have also jumped. A scenario with more tariffs will potentially lead to higher credit losses and bond yields. During the recession, the probability of defaulting on loans rises, which in turn can lead to non-payment of loan commitments, resulting in higher credit losses for banks. On another note, if bond yields rise, bond portfolio losses can increase, which in turn can lead to higher unrealized losses on banks' balance sheets.

REITs
Tariffs have a mixed impact on various REIT subsectors. For instance, infrastructure and data center REITs are relatively resilient, yet tariffs on technology-related imports could increase capital expenditures and pressure margins in the short term.

In office REITs, macroeconomic impacts caused by the tariffs could slow economic growth and weaken demand for office space, while retail REITs are vulnerable to tariffs on imported goods, especially from China. Higher prices may dampen consumer spending, leading to weaker retail sales and potentially reducing occupancy and rental income for retail landlords. Lastly, industrial REITs present a more nuanced outlook. While tariffs on imported goods could weigh on trade volumes and reduce demand for distribution space, the ongoing trend of supply chain realignment—including reshoring and nearshoring—may drive incremental demand for domestic warehousing, providing a potential offset and long-term tailwind.

Healthcare
Essential medical supplies, including medications, surgical gloves, and intravenous equipment, are imported, and the imposition of higher tariffs will lead to increased costs for these goods. With a substantial portion of active pharmaceutical ingredients (APIs) sourced from countries like China and India, the resulting price hikes will ultimately be passed on to patients.

Additionally, the proposed tariffs on pharmaceuticals could force manufacturers to reconsider their production strategies. While the intention is to shift more manufacturing to the US, this could lead to significant cost increases for companies, which may subsequently affect their investment in research and development. Industry leaders have warned that these tariffs could hinder innovation, as companies might have to make difficult choices between maintaining their workforce and funding new drug development initiatives. The complexities of pharmaceutical manufacturing further complicate the situation, raising concerns about the overall effects on the healthcare system.

Industrials
Tariffs are set to have different impacts within the industrial subsectors. In the freight and logistics sector, tariffs are expected to generate a significant reduction in volumes and cost pressures, negatively affecting earnings and margins. In the machinery and construction sector, tariffs will have negative impacts on production costs, especially for imported raw materials. Furthermore, an environment of persistent inflation due to tariffs and high interest rates will continue to impact demand in these sectors.

Food and Beverage
The impact of tariffs varies by company type, influencing their cost structures and profit margins. In 2024, imports from China comprised about 13% of U.S. imports, down from 21% in 2018, while goods from Canada and Mexico account for a significant portion of U.S. imports and exports. The U.S. packaged food sector could face temporary margin pressure from newly imposed tariffs, although the degree of exposure varies across the industry.

While most companies manufacture the majority of their products domestically, those with direct imports of finished goods, like Mondelez International, may encounter materially higher costs. Tariffs on raw materials, particularly fruits and vegetables from Mexico, dairy from Canada, and packaging from China, pose significant challenges. Although larger companies with diversified supply chains may find alternative domestic sources, these substitutes may not be as cost-effective. As tariffs roll into the costs of goods, companies may experience a lag in mitigating higher costs, similar to the previous inflation cycle where it took about two years to realize pricing benefits.

Consumer Services
The effect of tariffs is generally minimal. However, economic uncertainty and inflation fears are putting pressure on consumer spending, leading to lower revenues, decreased cash flow, and increased debt levels for these businesses. Quick Service Restaurants (QSRs) like McDonald's and Restaurant Brands International have low exposure to tariffs due to diversified supply chains and are mostly insulated from restaurant-level food costs.

However, if broad-based tariffs strain the overall economy, QSRs may see increased traffic due to their value-oriented offerings. Recent preliminary consumer sentiment has dropped, with consumers increasingly relying on savings and credit card debt, while the wealth gap widens. As costs for essentials like shelter, food, and services remain high, discretionary spending is further constrained. Consequently, there may be limited capacity for increasing dividends, with a higher likelihood of dividend cuts depending on the financial situation of each company.

Consumer Discretionary
Several industries within the consumer discretionary sector, such as luxury apparel retailers and fine dining establishments, could face added pressure from a loss of market confidence. U.S. consumer goods, many of which are imported from countries subject to high tariffs, will experience significant price increases in this new tariff environment, which will likely discourage consumer spending even further.

Key impacts of tariffs on the consumer discretionary sector could include increased costs, reduced demand, and supply chain challenges. Tariffs can potentially raise the cost of imports and raw materials, further squeezing profit margins. With higher costs being passed onto consumers potentially decreasing demand, and with companies shifting production from tariffed regions, additional costs and logistical complexities can exist.