When investing for income, don't get caught looking backwards

David Thornton

Livewire Markets

According to Market Index, 19 companies on the ASX currently have a trailing dividend yield above 10%. Very attractive income, in anyone’s book.

But income investors need to read between the lines. Trailing dividends are based on earnings over the past year, so you don’t want to go long on an income stock on the sole basis that it has a good history of paying dividends.

This is where total return investing comes in. You target the best of both worlds – income and capital growth. And you don’t want to fall into a dividend trap where one is traded off for the other.

So I reached out to Andrew Hamilton, Portfolio Manager for the Antares Dividend Builder Fund. Dividend Builder is an actively managed portfolio of high-yielding equities listed (or expected to be listed) on the Australian share market, which aims to deliver regular dividend income and moderate capital growth.

From a dividend builder perspective, whatever happens from a capital perspective, investors will be supported by that yield,” says Hamilton.

“And at the moment, on a grossed up basis for franking, we expect the dividend yield to be north of 7% as we look 12 months into the future.”

In this wire, Hamilton gives us his take on the health of the two big dividend-paying sectors: financials and commodities. Crucially, we cover the outlook in terms of dividends but also capital return - the two key components of total return.

Banks

With inflation soaring and the property market crashing, one would think that the banks are in serious trouble and, by extension, the sustainability of their dividends.

But Antares are still overweight the banks.

“As far as dividends go, we think the banks will be ok,” says Hamilton.

“Balance sheets are still strong; they’ll still be very profitable.”

The property crash is still yet to flow through to the banks. 

“Bad and doubtful debts are still really low, so low by historical standards that you’d say they have to go up, which will eat into profits.

“With interest rates rising, we would expect delinquencies to rise, and that eats into bank profits. Despite that we think profits will still be strong enough to pay solid fully franked dividends” 

Hamilton qualifies his bullishness on the banks with one caveat:

“What do banks look like in 10 year time? There’s the risk of disruption, which is one of many things our proprietary sustainability ratings take into account. But for the moment they look ok.”

Commodities

Investing in commodities stocks can be a catch-22.  

"When commodity prices are high, the cashflows resource companies get can be enormous and therefore the dividends can be too," says Hamilton.  

"But history tells us that when commodity prices get too high new capital gets attracted to the industry, new mines, and commodity prices fall drastically."

Things can get especially dicey when investing for income.  

"If a dividend fund is in a commodity stock at the wrong time looking for yield, they can end up getting into a lot of trouble on the capital side of things." 

"Because the dividend is based on last year’s earnings over the prior period, whereas the sharemarket is forward-looking and assesses prospects for profits over the next year or two."

The market might say ‘we know you’ve earned enormous cashflow over the last twelve months, and you’re going to pay a big dividend, but commodity prices have now fallen 20-40% and therefore your share price is falling 30-40%.'

So while the dividend may be great, the capital value gets smashed. 

Antares still have commodities exposure in Dividend Builder through diversified names with tier one assets, such as BHP Group (ASX: BHP)

Beyond that, Antares analyse long-run supply and demand to estimate reasonable long-run pricing. 

"So that means we can see at all times what commodity prices are implied in share prices versus current spot prices," says Hamilton. 

"We also require any company to have a strong balance sheet, margin for error, in terms of what’s implied in the share price vs long run commodity price, and then we have ESG ratings on all our stocks."

The energy sector has the same challenges, and one important other.  

"We do know two things: 1) oil is a sunset industry with climate change and technological progress, oil will be a thing of the past, and 2) oil and gas companies are reluctant to invest capital into exploration, discovery and appraisal."

Managed Fund
Antares Dividend Builder
Australian Shares

These days, oil and gas are dividend stocks. 

"That concept ten years ago would’ve been laughed at, because they were high return companies that had to reinvest."

The problem is, while oil and gas may be sunset industries, there's still going to be a lot of money made in the interim

"Every forecast I’ve seen for Asian oil demand has it growing over the next decade, so you’ve got a situation where the final cycle is going to generate very big returns."

The long-run oil price now is higher than what it was a few years ago, and this is supportive of stocks like Santos (ASX: STO) and Woodside (ASX: WDS).

However, high prices aside, what will these companies do the day after tomorrow?

Santos have recently made a final investment decision on a carbon capture and sequestration project in the Cooper Basin, and have their eyes set on doing the same in Darwin. 

"They’re talking about part of the transition being rather than just producing LNG and shipping it overseas, to also sequestering carbon. And where there’s a carbon price, you can get paid for that. Woodside are similarly persuing strategies involving hydrogen and other new energy technologies."

"It’s an acknowledgement that if they’re going to have a business in ten years time, it’s not just going to be producing oil and gas."

Access to regular income and capital growth

The Antares Dividend Builder fund is an actively managed portfolio of high yielding equities listed (or expected to be listed) on the Australian share market which aims to deliver regular dividend income and moderate capital growth. For more information, visit their website or fund profile below. 

Managed Fund
Antares Dividend Builder
Australian Shares
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This article has been prepared by Livewire on behalf of Antares Capital Partners Ltd ABN 85 066 081 114, AFSL 234483 (Antares). Antares is the investment manager for the Antares Dividend Builder Fund. Antares is a part of the Insignia Financial group of companies (comprising Insignia Financial Holdings Ltd ABN 49 100 103 722 and its related bodies corporate) (‘Insignia Financial Group’). The capital value, payment of income and performance of any financial product offered by any member of the Insignia Financial Group including but not limited to Antares, are not guaranteed. An investment in any product offered by any member of the Insignia Financial Group including but not limited to Antares, is subject to investment risk, including possible delays in repayment of capital and loss of income and principal invested. The information contained in this communication may constitute general advice and does not take into account your objectives, financial situation or needs. Because of that, before acting on this information, you should consider its appropriateness, having regard to your objectives, financial situation and needs. You should obtain the relevant Product Disclosure Statement or other disclosure document relating to any financial product which is mentioned in this communication, and consider it before making any decision about whether to acquire or continue to hold the product. Any opinion expressed in this presentation constitutes Antares’ judgement at the time of issue and is subject to change. Antares believe that the information presented is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made as at the time of compilation. However, no warranty is made as to their accuracy or reliability (which may change without notice). Past performance is not a reliable indicator of future performance. Returns are not guaranteed and actual returns may vary from any target returns described in this communication. Any projection or forward looking statement in this publication is provided for information purposes only and no representation is made as to its accuracy or that it will be met. Where applicable, information is based on information from sources believed to be reliable and accurate as at the time of preparation. Antares is not responsible for the accuracy of information provided by third parties, and is not liable for any loss arising from it. Livewire gives readers access to information and educational content provided by financial services professionals and companies ("Livewire Contributors"). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

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David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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