Income investors have been hit hard by 2020. Bonds are sitting at ~1%, yields are low, and dividends have been slashed. But according to Michael Maughan, Portfolio Manager at Nikko AM, Australian equities are the place to be for income investors. If you look in the right places, yield is everywhere.

“Dividends are going up from here. We’ve just had 30% cuts to dividends, so the next step for them is up.”

Michael shares his view on today’s market climate when investing for income, and shares two contrarian stock ideas which he labels his ‘Goldilocks stocks’ for income investors.

Transcript

Equity income has been a great source of income and long-term growth for investors over a very long period of time. My colleague, Mal Whitten, recently wrote a paper that details this and shows that historically you've got 4.5% yield before franking for the market for decades. We know this is going to be a tougher period that we're going into. The yield of the market will still be in that 3 - 3.3% range in the 12 months ahead (before franking), another percent say for franking, which still looks good against the alternative sources of income. Bond yields are going to be around less than 1.

Also, we're talking about that at a time where dividends are going up from here. We've just had 30% cuts to dividends. So the next step for that is up. Whereas, bond rates are going to be where they are for quite a long time.

In terms of when dividends are going to get back to where they were, I think that's probably going to take three years. If we think about the fact that earnings will take three years to recover, because we're going to have a stabilisation this year, hopefully a decent run rate out of 2021 into '22, but still probably another two years to claw back the profitability and margins that we've seen eroded in this last six-month period.

For dividends, I think it's interesting that what we're going to see is the next six months will be very uncertain, because Boards are going to have to really think about whether they want to dip into the buffers that they've built up over the last few months to pay a dividend, and that will come down to what line of sight they have on their future. I think that on a 12-month view, companies are going to be well-positioned to return to paying dividends, because I think that those payout ratios can step up quite quickly, given that it's a really good environment for recapitalising your balance sheet. Much better than the GFC. If we think about the GFC, companies couldn't find the liquidity to recapitalise themselves, and it took a very long time for that to recover. In terms of balance sheet rebuild, debt is very available. We've seen the credit markets and banks have been happy to step back in, and the equity markets have been very quick to step in if companies need to raise equity to fix their balance sheets. So payout ratios should be able to step back up on a 12-month view.

The Goldilocks stock for us as income investors, are the types of stocks that are uncorrelated to the normal cycles that companies go through, and show value and yield qualities. An example of that would be the protein plays in Ingham Chicken and Tassel Salmon. These are companies that haven't always been a good place to get that short income, but right now they've got strong contract, strong management, and strong balance sheets, so we see them as really good diversifiers where we can get, valuation upside, and consistent yield.

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Michael and his team invest in 40-70 companies on the S&P/ASX200, with the primary aim of providing tax-effective income alongside the potential for capital growth. For more information, please fill in the contact form below or visit the Nikko AM website.

This material was prepared and is issued by Nikko AM Limited ABN 99 003 376 252 AFSL No: 237563 (Nikko AM Australia). Nikko AM Australia is part of the Nikko AM Group. The information contained in this material is of a general nature only and does not constitute personal advice, nor does it constitute an offer of any financial product. It does not take into account the objectives, financial situation or needs of any individual. For this reason, you should, before acting on this material, consider the appropriateness of the material, having regard to your objectives, financial situation and needs. The information in this material has been prepared from what is considered to be reliable information, but the accuracy and integrity of the information is not guaranteed. Figures, charts, opinions and other data, including statistics, in this material are current as at the date of publication, unless stated otherwise. The graphs and figures contained in this material include either past or backdated data, and make no promise of future investment returns. Past performance is not an indicator of future performance. Any economic or market forecasts are not guaranteed. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided.