Rudi's View | Nov 22 2019
Dear time-poor reader: strategists are increasingly advocating investors adopt a bias towards cheaper "Value" stocks, plus dividends are growing globally, just not in Australia
In this week's Weekly Insights (this is Part Two):
-Is It Rotation Or Risk We Should Worry About?
-Are Dividends Telling The Story?
-*NEW* Research To Download
-Rudi On Tour
[The non-highlighted items appeared in Part One on Thursday]
Are Dividends Telling The Story?
By Rudi Filapek-Vandyck, Editor FNArena
You gotta enjoy it when research conducted by others offers more confirmation of your own share market insights and conclusions.
Local investment managers at DNR Capital dug deeper into the concept of buying cheaply priced blue chips on the Australian share market. Their main reference was the 1991 US Top Hit 'Dogs of the Dow'.
For those who are not familiar with the concept: US investor Michael O'Higgins published back then his discovery that buying share market underperformers was likely to generate market beating results as the laggards from last year turned into outperformers the next.
No, of course it doesn't work all the time, everywhere and under all circumstances. If it did, we'd all be rotating our complete portfolios at the end of each calendar year. Though that sounds counterintuitive by itself. The way the share market operates, all participants simply cannot be doing the same thing at the same time.
Returning to DNR Capital's research, typically a cheap blue chip in Australia is the one that offers a high yield, hence DNR's stock selection remained limited to the high yielders inside the ASX20.
In the words of DNR Capital, "the results were stark".
The Dogs of the ASX20 would have underperformed by circa -60 basis points over the ten years up until late 2018. Over the prior five years, that underperformance blew out to no less than -560 basis points.
Over the past year (2018), total return -even with the high yield and including special dividends- was a negative -7.3%. To which a cheeky DNR adds "fees excluded".
Year to date, meaning we started buying on December 31st last year and held onto the shares until the final day of September (when the analysis was concluded), the underperformance versus the broader market was yet another -2%.
On DNR's calculations, holding ANZ Bank ((ANZ)), BHP Group ((BHP)), CommBank ((CBA)), National Australia Bank ((NAB)), Rio Tinto ((RIO)), Scentre Group ((SCG)), Suncorp ((SUN)), Westpac ((WBC)), Wesfarmers ((WES)) and Woodside Petroleum ((WPL)) -the Dogs of the ASX20 at the end of last year- would have delivered 3% in additional income, including franking, but -5% less in capital growth.
One more additional insight from the DNR research: Over the last five years, yields from Materials and Energy companies have substantially increased, whilst for Consumer Discretionary, Utilities, Telstra ((TLS)) and Industrials companies, dividends have significantly declined.
And as I have been warning since the recent August reporting season: dividends from resources companies are now under threat because of lower commodity prices, plus the expectation that higher-for-longer iron ore prices won't be sustained.
Janus Henderson also released some research on dividends recently. On its numbers, total dividends paid out to shareholders hit an all-time record high in the US during the September quarter, while shareholders in Canada and Japan enjoyed record receipts for the quarter.
Now for the not so good news. Both Australia and China revealed their weakness throughout Q3. Shareholders in Australia were hit with a noticeable decline in dividends.
In China, nearly half of all companies in the index reduced their payout. In aggregate, there was still modest growth in Chinese dividends paid out, but that was dependent on large increases by two companies, reports the wealth manager.
In Australia, two out of every five companies in the index has been cutting dividends. Total dividends paid out have dropped to $18.6bn which, on Janus Henderson's numbers, represents the lowest pay out in US dollar terms since Q3 2010. Underlying, the decline was -5.9%.
It is Janus Hendersons' assessment that Australian companies have the lowest dividend cover in the world among the bigger economies. The direct consequence of this is that when the economy lands in a rough patch, corporate profitability goes backwards and without a sufficient buffer, those dividends cannot be maintained.
In similar vein, income investors in China feel more pain in the short term when economic adversity hits due to the fact that many companies in China have adopted a fixed payout-ratio policy.
Outside Australia, reports Janus Henderson, growth in dividends is slowing. The deceleration started in Q2 this year, continued in Q3 and is likely to slow further in 2020 as the global economic environment remains challenging. For the whole of calendar year 2019, Janus Henderson is sticking by its estimate that US$1.43trn will be paid out to shareholders globally. This would mark an increase at the headline of 3.9%, but underlying growth looks more like 5.4%.
While this is down from 8.5% underlying growth in 2018, it will still mark the tenth consecutive year of underlying growth in global dividends. Janus Henderson doesn't seem too worried about 2020, forecasting further slowing, but still growth in global dividends.
No specific forecast was given for Australia, but I think we can safely predict the picture for income investors in ASX-listed companies continues to look treacherous.
Jonathon Higgins, analyst at Shaw and Partners, really likes consumer loans provider Money 3 Corp ((MNY)). He thinks the stock can triple in value by FY23. That's in four years from now.
Post the recent AGM, where the company provided a "likely conservative" guidance for the running financial year, Higgins decided to elevate his Buy/High Risk call for the stock to "high conviction" status. The twelve month price target sits at $2.40. Now that the share price is falling, in line with the broader market, the distance between share price and twelve month target is looking more attractive by the day.
But Higgins' conviction goes beyond the next twelve months. As management at Money 3 is working on better debt and rates structures, including the option of securitising loans, the analyst suspects total assets can grow a lot higher than current expectations of $580m by FY23. He thinks $880m instead is not out of the question.
As these scenarios go, if Higgins' suspicion proves correct, this will have a material impact on the bottom line, which means upgrades will follow, which translates into a higher valuation for the company, add a higher quality/longer duration loan book, rising Net Interest Margin (NIM), Return on Equity (ROE) lifting… eventually management will have created the option to de-risk the balance sheet and increase distributions to shareholders via securitisation.
And investors will love every bit of it.
Before we know it this share price could triple, possibly quadruple in four years' time. Higgins thinks an extra $6 on top of a $2 share price seems possible. Now all investors need is for someone to hand that Shaw research report to management and tell them this is how you do it. Unless, of course, that information was already passed over from company management to the analyst at Shaw.
The view that investment portfolios might be best served through a bias towards cheaper "Value" stocks is not gospel for everyone, but we did notice the change in Macquarie's latest strategy report. In it, the strategists changed their view. They are now in favour of adding more weight to "Value" and reduce exposure to outperformers such as Goodman Group ((GMG)), REA Group ((REA)) and CSL ((CSL)).
The reasoning behind the move is that Macquarie sees enough evidence that a trough in global growth is near or maybe already behind us. This means the outlook for 2020 is looking better.
Normally at this point in the cycle, equity returns are negative and valuations considerably lower, point out the strategists. This time around, however, the Price-Earnings (PE) ratio for ASX Industrials is close to the highest level since the Internet Boom of the late 1990s. It is at the 99th percentile since 1960.
Macquarie's Model Portfolio has added BHP Group and Worley ((WOR)) to increase exposure to Resources. Other adjustments are switching out of Goodman Group and into Lendlease ((LLC)) instead; out of Stockland ((SGP)) and into Flight Centre ((FLT)) and out of APA Group ((APA)) and into Spark Infrastructure ((SKI)).
Clearly, what Macquarie is suggesting is that an improving economic outlook is going to force investors into cheaper priced "Value" stocks and cyclicals, including miners and mining services providers. But as the Model Portfolio holds on to stocks like James Hardie ((JHX)), Transurban ((TCL)), CSL, and a2 Milk ((A2M)), not everything trading on an above market valuation should be thrown out with the bathwater.
Macquarie's Model Portfolio holds no exposure to the local IT sector with the strategists commenting they are watching the sector closely for potential opportunities that might pop up.
In Part One of this week's Weekly Insights, I explained how strategists at Morgan Stanley do not see any upside for US equities next year. They believe valuations are way out of kilter for an economic recovery that will prove to be benign by all measurements.
Unfortunately, for Australian investors, Morgan Stanley holds no high expectations for the ASX200 either. The forecast is for the local index to remain range bound with a target of 6700 by year-end 2020. The index closed below that level on Thursday, but only after two days of relentless selling.
In general terms, Morgan Stanley finds local equity valuations look quite stretched, with any upside now closely linked to further growth in profits, while plenty of downside risk remains regarding consumer spending (or not spending).
Morgan Stanley's Model Portfolio too has added exposure to the "Value" end of the share market (read: Energy and Materials) while also shifting to Neutral on banks (from Underperform) now that a lot of the bad news has come out during the recent reporting season.
The forecast is that the dire situation locally will translate to a more coordinated monetary and fiscal response; but that won't happen until the second half, predict the strategists.
Model Portfolios over at stockbroker Morgans have taken profits on Macquarie Group ((MQG)), as that stock was growing into the largest holding in the Balanced Model Portfolio.
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Audio interview on Thursday: Threats And Preferences For This Year's Santa Rally:
Rudi On Tour In 2020:
-ASA Hunter Region, near Newcastle, May 25
(Part One of this story was written on Monday 18th November 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two was written on Thursday).
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