TOL - 8th May, 2023
6 ASX stocks with sustainably high dividends (and 2 on the way south)
In a world where inflation remains sticky and interest rates continue to tick higher, investors can still uncover sustainable yield.
According to S&P Dow Jones Indices research, the S&P/ASX 300 has a trailing 12-month dividend yield of 4.5%. This far surpasses the dividend yield of our developed market peers, with the UK boasting a 3.7% yield and the US just 1.7%.
Last year, total dividends paid out to investors totalled a record $113 billion. S&P Dow Jones analysts found that our market's dividend pool has grown at a compound annual growth rate (CAGR) of 6.5% over the past 10 years - far higher than the RBA's inflation target of 2%.
In fact, 148 companies increased their dividends in 2022, despite the S&P/ASX 300 falling quite deeply into the red. In total, 216 companies paid out dividends last year.
As it currently stands, there are 32 stocks within the S&P/ASX 300 with trailing yields higher than the long-term average market return of 8%. Without stating the obvious, this is far higher than the Australian market's average of 4.5%.
As the saying goes, when something looks too good to be true, it usually is.
So in this episode, Livewire's James Marlay was joined by Antares Equities' Andrew Hamilton and Plato Investment Management's Peter Gardner for their analysis of the equity income spectrum, as well as the stocks they believe can continue to pay out sustainably high dividends from here.
Plus, because we all know this anonymous writer loves a dash of drama, we asked Peter and Andrew to each name one double-digit yielder likely to face dividend-paying challenges from here.
Note: This interview was filmed on Wednesday 3 May 2023. You can watch the video, listen to the podcast, or read an edited transcript below.
Edited Transcript
James Marlay: Hello and welcome to Livewire's Buy Hold Sell. My name is James Marlay, and we're talking about dividend yields and dividend-yielding stocks in an environment where we're seeing interest rates and inflation push up. We've got about 32 stocks on the ASX that are yielding higher than the long-term return of 8% or so, which obviously presents at face value, an attractive opportunity. But is that an opportunity or a trap? We're going to be talking with a couple of experts in dividend investing today. We've got Andrew Hamilton from Antares and Peter Gardner from Plato. Gentlemen, great to have you on the show.
Well, let's start with high yields. Very alluring, but they can be deceptive. What are some of the lessons you've got for investors on high yields?
Why high yields can be deceiving
Andrew Hamilton: Absolutely they can be deceptive. Part of the reason is that yields are a function of both dividend and price, and it's really like the market. When the yield is too high, the market is effectively flashing warning lights telling us it doesn't believe the dividend.
James Marlay: Peter, I mentioned in my introduction, 32 stocks with yields 8% or higher. That is a retrospective view. In that 32, are we likely to find some opportunities or is it all flashing red lights?
Peter Gardner: There are obviously going to be some opportunities, but the majority are going to be flashing lights for the reasons Andrew gave. And the other thing I'd add to that when we look at that yield, we're looking historically, so we're saying the last 12 months of dividends versus the current price. You're not looking at what the forward dividends are. And so often stocks are on high yield because their current price has fallen significantly, and so the market is obviously telling you something. If the price is dropping, it's saying that the earnings prospects of a company are dropping and therefore their dividend prospects are likely to drop as well.High yielding miners: Coal continues to look attractive
James Marlay: That category of stocks that have fallen or had a share price fall over the past 12 months definitely populated that list of high yield stocks when I looked at it. The other category was filled with miners and energy-producing companies, which are a bit of an anomaly when you think about high yielding stocks. How should we be thinking about those stocks, because they have been a great source of income and have surprised a lot of investors over the past 12 months?
Peter Gardner: I mean it obviously depends on which stock you're talking about. We're fans at the moment of the coal miners, even though they're sitting on very high yields and the coal price has come back a fair amount, we still think that the short to medium-term dynamics for coal are pretty good. Obviously, in 30 years' time, there's probably not going to be any coal produced, or we hope for the environment that there won't be any - at least that's not being captured in terms of carbon capture. But for the short to medium term, we think the coal price is strong right now, so the prospects are pretty good.
How fundies are competing with less risky products (like term deposits)
James Marlay: Okay. Andrew, let's just back it up a little. If we look at equities as a source of income, they're competing against less risky asset classes like cash and fixed income products at the moment. How are you navigating the challenge of providing that income from equities whilst reducing the risk and competing with those less risky products?
Andrew Hamilton: So for us, really what we try to do is assess the sustainability of the dividends. We do a sustainability assessment of the business model as a whole and the capital that each company has at its disposal, not just financial, but whether it be intellectual property or human capital, community relationships, etc, to try to understand how sustainable business models are and their future cash flows and therefore the future dividends.
I would argue that equity income is very important in a portfolio because you have the opportunity for capital growth as well. Term deposits might pay you a few per cent, but ideally with equity income, we can build a portfolio as a whole that will yield significantly above that and generate equity growth over several years and through the cycle to support the capital base of the investors.
James Marlay: And so has the backdrop with the higher interest rates and higher inflation made that job harder?
Andrew Hamilton: It does to a degree as the market sort of adjusts to more, shall we say normalised interest rates. But the key for us as portfolio managers is to diversify. We don't get every stock right. The key thing an investor gets by investing in a portfolio is the outcome of the total portfolio, and so we seek to diversify as many positions as we can and diversify across industries. Some industries are more interest rate sensitive than others. So we hope that for the portfolio as a whole, we can yield significantly in excess of what the benchmark yields and also provide some capital growth.
James Marlay: Pete, income investing, it's all you've ever done. What are the challenges now compared to previous market cycles, given the backdrop we're looking at?
Peter Gardner: I mean the challenges are definitely less for Australia than for other global markets in terms of interest rates increasing, and that's partially because of the types of sectors that our market is overweight. We're generally overweight miners. Miners generally do okay in a high inflation, high interest rate environment. They generally have low levels of debt.
Financials are the other area that Australia is overweight, and they generally do pretty well in a higher interest rate environment, and that's why last year when the overall US equity market would've fallen around 20%, the Australian market was pretty flat over that time because of that difference in structure. So I definitely agree with what Andrew's saying in terms of having a diversified portfolio where the dividends can also grow over time is really important for investors.
We've got this chart that shows that if you invested $100,000 in equities back in 1980 and that was a good time to invest, that would now grow to produce income of $85,000 each year. Now obviously that's variable, you're going to get highly volatile earnings compared with investing in term deposits, but there's a potential for growth there, which historically over time has worked quite well.
6 sustainable dividend payers
James Marlay: Well, you talked about sustainability. Could you give an example to our viewers of a company where you've done that work on not just the sustainability of the actual dividend number, but the business in its entirety that you think can tick the boxes for you?
Andrew Hamilton: There are quite a few stocks - most of the portfolio is made up of stocks that we see as just strong in their sustainability rating. We do an internal sustainability rating and a ranking across about 180 stocks that we cover formally, and most of the portfolios score very well in that respect.
Our portfolio has CSL Limited (ASX: CSL) in it, even though it does yield a lot less than the benchmark, it does have a yield and we expect that dividend to grow over time because we have quite strong forecasts for their cash flow growth. It will never be a high yield stock, but from a total return perspective, that adds quite a lot to the portfolio, that's very sustainable.
But equally, there are other stocks, say the banks. Most income portfolios in Australia are obviously pretty heavily overweight the banks. I think we are probably a bit less overweight than many, but we do still own the banks, we are overweight. They're dividends are clearly sustainable and they are very well capitalised. The Australian oligopoly [Commonwealth Bank (ASX: CBA), ANZ Group (ASX: ANZ), National Australia Bank (ASX: NAB), and Westpac (ASX: WBC)] is very strong, so I would expect those fully franked yields to continue. Even if there is a significant recession and the dividends do go backwards a bit, those yields will still be above the benchmark because as I say, they're very, very well capitalised.
James Marlay: Okay. This question is about sustainable dividends with the potential to grow. Have you got a pick for us, Pete?
Peter Gardner: My pick would probably be Medibank Private (ASX: MPL) at the moment. It's in a pretty solid industry with defensive growth. Obviously, they had their hiccup with the cyber incident that they had, but if you look at what happened to their customers, they didn't actually see many customers leave the business after that. I guess the data had already been stolen, so it was too late to leave at that point. But we generally see with these kinds of incidences that there is lower churn than the market expects, and so that turned out to be a pretty good time to invest after that cyber incident. We think Medibank Private is a good stock going forward. It actually benefits from higher interest rates because they get to invest the premiums in bonds, which are then yielding a higher amount, so their investment earnings go up. And so we think it's got good sustainable dividends going forward.
Andrew Hamilton: I agree 100%, by the way, it's one of our biggest overweight positions with a pristine balance sheet and a management team that we regard very highly.
2 stocks with dividends likely heading south
James Marlay: Okay, great. We're going to turn back to the start of the show where I talked about stocks on really high yields. Could I get you to pick a company where the yield is double-digit, but you think that yield is at risk and the dividend could be cut just to illustrate that example?
Peter Gardner: Our pick would probably be Magellan (ASX: MFG). And this isn't a take at all on Magellan's future investment performance, but rather it's just an indication of their funds under management (FUM) dropping over the last 12 to 18 months. And so, with a funds management business, they generally have a large number of fixed costs, and then their revenue - as that goes up and down - has an outsized impact on their profit going forward. And that's positive when your revenues and your FUM is going up. But that's also a negative when your FUM is going down. And so that's what happened to Magellan. Their FUM has dropped significantly for ... probably most viewers are going to know the reasons.
And so that just means that their profit is dropping and therefore their dividends are dropping. So we just think investors need to be aware with Magellan that the yield that they got in the last 12 months is unlikely to be the yield they get in the next 12 months purely just because that FUM has dropped. Now in terms of when you would invest in Magellan going forward, we'd want to see a stabilisation of that FUM and an improvement in their investment performance.
James Marlay: Okay. Andrew, have you got an example of a stock on a really high yield where you think the dividend could be at risk?
Andrew Hamilton: There are a number of stocks where I would argue that optically the dividend looks high, but it's not going to be delivered. When we buy a stock in the portfolio, a new stock, we hope to be able to own it for three years or more, it depends obviously what happens. But it's not just one dividend or two dividends, we're looking for five or six. So even if that first dividend is delivered on a high yield, we think that they'll decay. Look, many of them are resources stocks as commodity prices have been elevated. I can think about something like Deterra Royalties (ASX: DRR), that's a pure income stock because they pay out 100% of their earnings. It's really just royalties from iron ore licences. But it's a single commodity, iron ore, and we see risk to the iron ore price on a one or two-year view. Even if it stays fairly strong, I think we might see their dividend decline looking forward, and so the yield that you think you're going to get might not be delivered.
James Marlay: Well, that's all we have time for today, folks. I hope you took some nuggets away from our two dividend experts. Remember to check in to our YouTube channel. We're adding fresh content every week.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
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Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
Expertise
Livewire Markets
Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.
Expertise
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