Here are three stocks that reported satisfactorily during the recent company earnings season, and which meet my requirements for a good income stock – boring, predictable, lower volatility and paying a reasonable distribution. Importantly, the capital risk is relatively low.
That’s not to say that they can’t go down in price (if the market tanks, all stocks suffer collateral damage), but outside this or a single event risk, the downside risk is limited. Conversely, there is also limited upside potential, so if capital gain is your main driver, they are not for you.
Forecast distributions range between 4.0% and 6.0%.
1. Charter Hall Long WALE REIT (CLW)
Charter Hall Long WALE REIT is a $3.6bn property trust that owns a portfolio of high-quality real estate assets with a long WALE (weighted average lease expiry). The WALE is currently 14.0 years.
There are 386 assets across industrial and logistics, retail, office, telco exchanges and agri-logistics. By value, approximately 30% is in industrial, 28% in retail (BP service stations, pubs and bottle shops), 28% in office and the balance in telco exchanges and agri-logistics. The portfolio occupancy was 99.8% as at 30 June.
Portfolio credit quality is high with 75% of tenants (by income) independently rated ‘investment grade’. Of the balance, this includes names such as Brisbane City Council, Inghams and Arnott’s.
Balance sheet gearing is 24.2%, which is below the CLW’s target range of 25% to 35%.
In FY20, CLW delivered operating earnings of $121.9m, or 28.3c per unit. It has a policy to payout 100% of operating earnings (net property income less operating expenses and finance costs), and paid out 28.3c per unit in distributions.
For FY21, it has guided to operating EPS of no less than 29.1 cents per unit, reflecting operating EPS growth over FY20 of no less than 2.8%. The target distribution payout ratio remains at 100% of operating earnings, or no less than 29.1 cents per unit.
On Friday’s close of $4.93, this puts CLW on a forecast yield of 5.9% pa (unfranked).
Charter Hall Long WALE REIT (CLW) – 11/16 to 8/20
CLW’s unit price has rallied strongly and it is trading at about a 10% premium to the REITs NTA (net tangible asset value). According to CLW, its NTA at 30 June was $4.47.
In the absence of further compression in capitalisation rates (which is probably unlikely given the challenges in office and retail), it is unclear how this “gap” is going to be narrowed. Further acquisitions and increased leverage could go some way.
Notwithstanding that CLW looks expensive, the brokers remain favourably disposed. According to FN Arena, of the 4 major brokers that cover the stock, there are 2 buy recommendations and 2 sell recommendations. The consensus target price is $5.25 (range $4.73 to $5.59), a 6.4% premium to Friday’s close of $4.93.
2. APA Group (APA)
APA owns and operates about $22bn of energy infrastructure assets. This includes 15,425km of gas transmission pipelines, 29,500km of gas mains and pipelines that connect to 1.4m gas consumers, gas fired power generators, wind and solar energy generators, gas storage and gas processing facilities, and electricity transmission lines.
Overall, approximately 90% of APA’s revenue is ‘take or pay’ being either capacity charge revenue, regulated revenue or contracted fixed revenue. This means it is relatively fixed and not subject to short term variable demand. APA says it is supported by long term contracts with customers of whom 93% are investment grade quality, and that the revenue weighted average contract tenor remaining is 12 years.
Because the revenue is reasonably predictable and the assets are capital rather than labour intensive, APA is able to guide to a high degree of confidence its expected financial outcomes. The chart below shows that not only has EBITDA (earnings before interest, tax, depreciation and amortisation) increased each year since 2009, but that APA has provided a narrow earnings guidance range and importantly, has delivered within that range or marginally exceeded it.
APA: Actual EBITDA and EBITDA Guidance – 2009 to 2020
For FY20, APA delivered EBITDA of $1,654m. This was right in line with the market’s forecast, and at the top end of APA’s earlier guidance of being in the range of $1,635m to $1,655m. But looking ahead to next year, the company guided to EBITDA of being in the range of $1,625m to $1,665m, with interest expense of $490m to $500m (FY20 was $497m). Importantly, it left its distribution guidance for FY21 to be “substantially in line with FY20 distributions” – 50c per share – which was less than the market’s forecast of around 52.3c per share.
Based on Friday’s closing price of $10.28, the 50c distribution (of which about 7c will be franked), puts it on a forecast yield of 4.85%. With franking it grosses up to 5.1%.
APA Group – 8/15 to 8/20
In regard to 2021, APA Managing Director Rob Wheals said: “we are confident that APA is in a strong position financially and operationally. Although APA is an essential part of the energy supply chain, no business is entirely immune from an economic downturn. While our capacity contracts and regulated revenues mean that our business is somewhat resilient through economic cycles, APA’s revenues are still subject to recontracting decisions by customers, throughput volumes on certain contracts, the timing of customer investment decisions, as well as lower CPI across the contracts portfolio”.
As an investment thesis, APA has a low risk business model built around stable cash flows, majority take or pay contracts with CPI adjustments, long term contracts, established customer relationships and a portfolio of high-quality, long life assets. Its strong credit metrics (it has an investment grade rating) provide balance sheet flexibility.
Will APA pay a distribution of 50c in FY21? Most likely. Will it pay 47c? Possibly. Will it pay 53c? Possibly. Will it pay 40c or less? Unlikely.
But that’s the point about APA. Steady, boring and pretty reliable. Arguably, exactly what an income investor wants.
The broker analysts have a target price of $11.24 for APA, 9.3% higher than Friday’s close. There are 3 buy recommendations and 4 neutral recommendation (no sell recommendations).
3. Medibank Private (MPL)
Despite the challenges facing private health insurance, in particular participation and affordability, I like Medibank Private because over the last few years, it has increased its number of policyholders and its market share. When you are the clear market leader in a highly regulated market, this is hard – so this tells me that under CEO Craig Drummond, the team at Medibank is executing well. Further, it is advancing a number of initiatives such as in-home care, health and wellbeing services, and telehealth ancillary services to create a competitive advantage in health insurance.
Over the course of FY20, it grew policyholders by 0.6% or 10,600. An increase of 28,400 in the ‘ahm’ brand offset a decrease of 17,800 in the ‘Medibank’ brand. This was lower than anticipated due to Covid-19 suspensions. Market share increased by a net 0.04%.
In Medibank’s main health insurance division, operating profit fell from $542.5m to $470.6m. This represented a deterioration in operating margin (profit as a share of revenue) from 8.4% to 7.2%. An increase in net claims expense of 3.2% couldn’t be offset by an increase in net premium revenue of 1.3% and a reduction in management expenses.
As a result of COVID-19, hospital admissions for elective surgery and the demand for ancillary medical services fell, resulting in lower than expected claims of $364m. Medibank elected to book $297m of this as a deferred expense, leaving only a net reduction of $67m. A freeze on premium increases, plus customer relief measures, caused an $80m impact in the fourth quarter.
Investment income also plunged due to ‘mark to market’ losses, from $102.8m to $2.4m. Underlying NPAT fell by 18.1% to $366.7m.
Shareholders will receive a final dividend of 6.3c per share taking the full year dividend to 12.0c (fully franked) per share. This represents a 90% payout of underlying NPAT.
Looking ahead to FY21, Medibank said that it expected its net claims expense to increase broadly in line with FY20, implying a small deterioration in margin. Against this, it has a productivity target of $20m and it aims to increase policyholders by more than 1%. For shareholders, the dividend payout ratio is expected to be at the top end of the target range of 75% to 85% of underlying NPAT.
On consensus, the major brokers forecast a dividend for Medibank in FY20 of 11.9c (range 11.0c to 13.4c), and for FY22, a dividend of 12.2c. Based on Friday’s closing price of $2.81, this puts the stock on a prospective yield of 4.2% (fully franked), or grossed up, 6.0%. The consensus target price is $2.79, 0.8% lower than the last close.
Medibank Private (MPL) – 8/15 to 8/20
But as Credit Suisse commented: “Medibank Private is not a stock that will deliver significant earnings growth, but the downside risk is not extreme and there is an opportunity for favourable reforms in the October budget”. I would add that Medibank’s capital position is strong and that there isn’t that much risk on the dividend.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.