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In Search Of The Dividend Sweet Spot

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | May 21 2020

Dear time-poor investor: new research by Morgan Stanley has identified ASX sweet spots for dividend-oriented investors

In Search Of The Dividend Sweet Spot

By Rudi Filapek-Vandyck, Editor FNArena

This is the third, and final, instalment in a three parts series on dividends and investing in the Australian share market.

History shows dividends make up 50% of total return from equities, or more depending on how far we go back in time, but the subjugation of bond yields globally has made income-hungry investors increasingly dependent on dividends paid out by listed companies.

With many strategies centred around buying and holding high yielding stocks, the fall-out from the covid-19 pandemic for Australian investors is proving exceptionally damaging with high yielding share prices falling deeper and recovering less, only to be followed up with dividend cuts and deferrals, if not a fresh equity raising on top.

The first installment explains why your garden variety dividend/income strategy of only buying high yielding stocks with extra franking credits essentially amounts to high risk. Such portfolios have been hit the hardest in 2020.

The second installment identifies where investors can find dependable and sustainable yield/dividends in a market environment that is dominated by uncertainty, capital raisings, and dividend reductions.

The third installment predominantly leans on research done by analysts at Morgan Stanley which led to an in-depth 31-page report, released at the end of April under the title “We’re Going on a Yield Hunt”.


Bigger picture, Morgan Stanley’s research highlights the two sides that make up the conundrum for income-hungry investors eyeing the Australian share market for future income.

On one hand, Australian equities remain among the highest yielding in the world. Even with all the deferrals and cuts happening, the report still estimates average yield remains above 4%, and is forecasted to remain above 4% for the years ahead.

This settles the ASX firmly among global leaders in terms of yield/income available for investors, even without any franking (which doesn’t apply for foreign investors). Very few offshore markets do better, but the UK and Singapore do.

Of course, in many cases the higher yielding stocks are carried by little, if anything, in investments while boards have substantially lifted payout ratios in years gone by to keep the party going for loyal and appreciative shareholders.

This story has now broken down. Economic growth in Australia has been trending down for a while, and the lack of investments by these companies is one major driver as to why. By late last year cash profits increasingly could no longer sustain the prior year’s dividend.

Less than six months later, the global covid-19 pandemic and subsequent government ordered lockdowns have ensured this year’s losses in dividends in Australia will be much larger. Morgan Stanley has joined other experts, including peers at UBS, in suggesting total damage will be the largest post-GFC and in many respects 2020/21 will mimic what happened during calendar years 2008/09.

We are already witnessing fresh capital raisings on a large scale by companies whose balance sheet and cash generation no longer support paying out a dividend. In addition, Morgan Stanley suggests boards will use this year’s emergency settings to scale back unsustainably high payout ratios.

The impact from lowering the payout ratio to what might be a more sustainable level, potentially around the long-term average of 65% in Australia, will inflict more pain for investors loyal to their beloved champions from times gone by.

It means, explains the report, not only will dividends take a dive in 2020, but the recovery in the years ahead on lower payout ratios will be noticeably slower.

Banks Under Scrutiny

Within this context, the sector that immediately springs to mind are Australian banks. All will be facing the additional restraint of having to rebuild capital buffers, point out the analysts.

Investors relying on history repeating with bank dividends rebounding sharply in 2010/11 will have to scale back their expectations.

In concrete numbers: Morgan Stanley sees dividends from banks remaining well below FY19 payouts for multiple years into the future (the report only looks out as far as FY22).

The analysts agree CommBank ((CBA)) will prove most resilient in the sector locally, but they are not in favour of CBA shares retaining their rather large valuation premium vis-à-vis its more vulnerable peers.

Others, such as sector analysts at CLSA, have no such restraints. On Monday, CLSA repeated its Outperform rating for CBA in a report titled “The Safe Play”, with a slightly raised price target of $65.02.

CLSA’s comment: “…while CBA’s valuation looks stretched relative to the other majors, we believe it is justified given the strength of its capital position, likely ability to pay above-peer dividends, provision levels above peers, and likely continued mortgage market share growth.

Market strategists at JP Morgan note the Australian share market has underperformed other developed markets by quite the margin over the past three months; the MSCI Developed Markets outperformed by 670 basis points.

Apart from Australian banks representing such a prominent index weight, JP Morgan also suggests the veracity with which companies here have started to raise fresh capital, plus the big dividend reductions this early in the downturn are likely co-responsible.

Year-to-date dividends from ASX200 companies have already been scaled back by -27%; by far the largest reduction across the globe, on JP Morgan’s numbers.

JP Morgan research suggests there is a high correlation between index performance on a three-month assessment and the gravity of dividend downgrades.

Resources In Focus

The loss in reliable (?) dividends from the banks almost inevitably raises the profile of Australian resources companies, in particular with the price of iron ore remarkably stable and gold producers enjoying boom times.

The one obvious point to highlight here is that history shows both share prices and dividends from these companies can be extremely volatile. Investors need not look any further than this year’s carnage among energy producers, at times equally revered for their attractive looking yields.

Short-term, however, it is difficult to fault producers including BHP Group ((BHP)), Fortescue Metals ((FMG)) and Rio Tinto ((RIO)) as relative stability in their core markets is now being matched by deleveraged balance sheets, optionality in capex and above-average generation of free cash flow.

In some cases the widening impact from the global pandemic is restraining supply, effectively putting a floor under prices.

Sure, dividends from commodity producers will always remain beholden to economic and idiosyncratic cycles but in the "right now, right here" when many an investor is looking for alternatives, miners are offering bank-alike, above market average dividends at a time when banks and many other traditional providers of income have gone missing.

FNArena’s Stock Analysis (and Sentiment Indicator) reveal New Hope Corp ((NHC)) shares are currently cum 7% yield for the year ahead on market consensus forecasts, while Alumina Ltd ((AWC)) offers 5.18% but investors should be well aware of the higher risk profile that comes with these forecasts.

The ASX100 Resources segment currently offers an estimated dividend yield of circa 4.7% for the year ahead.

The team of resources analysts at Citi has equally stuck its neck out for market beating dividends from mining companies this year, led by BHP Group, Rio Tinto, and Fortescue Metals.

Champions Of Sustainability

Combining operational prospects with share prices, yield and quality assessment filters, Morgan Stanley’s research has highlighted twenty companies that might as well be dubbed the 2020 Sustainable Dividend Champions on the ASX.

These twenty companies are: Macquarie Group ((MQG)), Amcor ((AMC)), Ansell ((ANN)), Aurizon Holdings ((AZJ)), Boral ((BLD)), Carsales ((CAR)), Coca-Cola Amatil ((CCL)), Cimic Group ((CIM)), Coles ((COL)), Crown Resorts ((CWN)), Dexus Property ((DXS)), GPT Group ((GPT)), Mirvac Group ((MGR)), Orica ((ORI)), QBE Insurance ((QBE)), Reliance Worldwide ((RWC)), Sonic Healthcare ((SHL)), Suncorp ((SUN)), and Woolworths ((WOW)).

The list consists of a few financials, a number of property developers, but also some highly cyclical exposures. History suggests share prices for the likes of Orica and Reliance Worldwide can be just as volatile as those in the mining sector, so investors should take this into account when doing their own research.

Equally important is that Morgan Stanley’s research runs contrary to market forecasts for companies like Boral and Crown Resorts.

The Morgan Stanley report also offers a selection of stocks for investors who want to play the theme of “dividend recovery” with the analysts suggesting the following companies should be firmly in dividend recovery mode by FY22, in some cases potentially able to again match the FY19 dividend (or better):

Vicinity Centres ((VCX)), Stockland ((SGP)), Scentre Group ((SCG)), Downer EDI ((DOW)), QBE Insurance, Boral, Nine Entertainment ((NEC)), Suncorp, Atlas Arteria ((ALX)), Cimic Group, Challenger ((CGF)), GPT Group, Lendlease ((LLC)), Spark Infrastructure ((SKI)), Crown Resorts, Tabcorp ((TAH)), Aurizon Holdings, Sydney Airport ((SYD)), Amcor, Macquarie Group, Dexus Property, Mirvac Group, Qantas ((QAN)), Coca-Cola Amatil, and Charter Hall ((CHC)).

The above list are the current stand-outs on forecast FY22 dividends. The overlap with the prior list suggests not all companies mentioned will have to cut first before looking attractive on FY22 forecasts.

ASX Dividend Sweet Spot

In line with my own suggestion made in the second installment, Morgan Stanley analysts believe the contemporary sweet spot for dividend hunters in the Australian share market lays with stocks offering circa 3% in forward looking yield, underpinned by growth.

It’s what the report summarises as GARY; Growth And Reasonable Yield.

Applying all applicable filters, has generated a list of 30 names (a few inclusions will certainly surprise):

Jumbo Interactive ((JIN)), Charter Hall, Ansell, Pendal Group ((PDL)), Super Retail Group ((SUL)), Perpetual ((PPT)), Aurizon Holdings, Amcor, Coca-Cola Amatil, Sonic Healthcare, Spark New Zealand ((SPK)), Coles, Adelaide Brighton ((ABC)), Medibank Private ((MPL)), Baby Bunting ((BBY)), Link Administration ((LNK)), Dexus Property, Orora ((ORA)), ASX Ltd ((ASX)), Magellan Financial ((MFG)), Orica, Incitec Pivot, Reliance Worldwide, Boral, Woolworths, Crown Resorts, Macquarie Group, APA Group ((APA)), Carsales, and AusNet Services ((AST)).

On Morgan Stanley’s forecasts, Australian companies ex-Resources are poised to reduce their dividends by -60% for the second half of FY20, which then results in total dividends-per-share (DPS) decline of -30%-40% for the financial year.

The average payout ratio is expected to fall to 65% from 75%.

Both key forecasts imply analysts forecasts still need to reset a lot lower from current numbers.

Also, if the assumptions behind these forecasts prove correct, total losses in dividends/income for Australian investors might end up exceeding those during the GFC.

Back then, DPS fell by -30% peak-to-trough while earnings declined by -43%, but payout ratios were not pared back. Nevertheless, it took more than 10 years before total DPS rose back above the 2007 peak.

(This story was written on Monday 18th May, 2020. 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).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: or via the direct messaging system on the website).



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