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Election sorted – time to look at dividends again

With the unexpected – or as one particular person described it “miraculous” – Coalition election victory, the storm clouds of dividend franking reform have cleared.  So now we can sleep well at night knowing we can bank out franking credits, let’s have a look at what’s on offer for the income-seeking investor.

Looking across the spectrum of income-producing assets, equities in general, and a portfolio of higher-yielding equities in particular, continue to stack up well. The chart below shows the typical pre-tax income yields on offer from a range of investments:

In recent times, we have seen the yields on Australian Government bonds fall to historically low levels as the RBA has indicated that it has moved to an easing bias on the back of a slowing in economic growth and persistently low inflation.  Should rates be cut over the second half of the year, then the term deposit rates offered by the banks are also likely to fall from their already low levels, making them an even less attractive investment.  This will also likely flow through to the rates paid on hybrids, which are generally linked to underlying interest rates.

By contrast, the outlook for dividend generation by Australian shares remains robust.

Starting first with the major banks.  While the set of results just reported showed them having a torrid time, being slugged with large remediation costs on top of moribund earnings, we believe that we are likely close to a bottom. The Coalition victory should be positive for the housing market, with negative gearing remaining in place and capital gains tax unchanged and be generally positive for economic sentiment.  If this leads to a stabilisation in house prices, then credit growth could be expected to tick up and sentiment towards the banks to improve.  Further, recent announcements by the regulator in Australia have been aimed at loosening up the flow of credit.  Against this backdrop, it is reasonable to expect the banks to continue to pay an attractive level of dividends, with the sector offering an average gross yield next year of around 8.5% (6).

Moving to the other end of the market and looking at the large cap resources stocks, we see a similarly positive outlook for dividend payments. While the very large cash returns via off-market buybacks seen over the last 12 months are unlikely to be repeated, ongoing strength in commodity prices and continued capital expenditure discipline will likely see the sector generate very strong cash flows. This, combined with very strong balance sheets, is likely to see the resource majors continue to deliver strong dividends to shareholders over the coming periods.

Looking across the rest of the market, the outlooks for individual companies are as diverse and varied as their underlying operations.  However, one feature of corporate Australia in recent years has been its financial strength, with corporate balance sheets overall in very good shape. The chart below highlights how corporate gearing levels have declined over time and are currently at very low levels (7).

In our view, a company’s balance sheet is like the foundations of a house – the stronger the better – with a strong financial position being critical for a company to be able to grow its business, weather the downturns that inevitably occur and, critically, pay dividends to shareholders.  As a result, balance sheet strength is a critical factor in our assessment of stocks as potential investments.

Outside of our holdings in banks and large resources stocks, we are finding many good investment opportunities across a range of sectors. Examples of companies we currently hold which are trading on reasonable valuations and offering attractive dividend yields, include Macquarie Group, Medibank Private, Star Entertainment and Tabcorp.  Each of these companies has healthy medium-term earnings prospects and can be expected to pay growing streams of dividends to investors.

Overall, out portfolio offers a higher forecast gross yield than the overall market and, as always, our focus will continue to be on investing in quality companies which are offering attractive valuations and have the ability to deliver high levels of franked dividend income to investors. Further, we believe that the current very low interest rates highlight the relative attractiveness of financially-sound, high dividend yielding equities.

 

By Stephen Bruce, Portfolio Manager, eInvest Income Generator Fund (Managed Fund) (code: EIGA) To find out more about EIGA, please click here.

This article is the opinion of the Stephen Bruce and is not financial advice. Speak to your financial adviser or broker for more information. I’m sure they’ll be happy to help you. Don’t forget to always read the Product Disclosure Statement (PDS) for the active ETF you are invested in. To find out more and to find the PDS please visit einvest.com.au

Source: (1) Factset as at 22-Apr-19 (2) RBA (3) Typical hybrid yield (4) Based on PVM forecasts (5) This is a target and actual results may differ materially (6) Factset consensus as at 22-Apr-19 (7) Deutsche Bank.