Income-oriented Australian investors have long used the stock market as a source of dividend income, helped by the dividend imputation system, in particular its munificence to low-tax-rate investors, such as self-managed superannuation funds (SMSFs).
As official interest rates have slid over the last decade from 7.25% to a record low of 1.5%, and term deposit rates have more dropped from the 7%-plus levels to average five-year territory of 2.6%, fully franked share dividend yields in the 4%–5% range – which generate a grossed-up yield of 5.7%–7.1% – are routinely achievable on the stock market.
But several recent developments have clouded the view.
The first is the reminder from the stock market that when using shares for dividend income, the capital risk of a falling share price cannot be ignored. Telstra has been the most prominent example of this, but the hammerings given to the banks’ share prices in the wake of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has also given income-oriented investors a shock.
A year ago, for example, Telstra was trading at $4.30: on the expected 31-cent dividend, it was yielding 7.2%, fully franked.
But in August 2017, Telstra announced that it would pay out between 70%–90% of earnings in dividends, rather than close to 100%. It was the first major change in dividend policy since the telco was floated by the government in 1997. On that basis, Telstra’s payout to shareholders could be expected to fall to about 22 cents, fully franked, as the company tried to weather the impact of the national broadband network (NBN) on its profits. At 22 cents, the new expected yield (at $4.30) was 5.1%.
A year down the track, and Telstra is trading at $2.64 – and at its strategy day last month, the company admitted that a dividend of 22 cents was no longer achievable, largely because the mobile margins cannot be sustained. Analysts cut their consensus dividend expectation for FY19 to 17 cents. An investor who bought the shares a year ago at $4.30 will see a yield for FY18 of 5.1%, but the new FY19 dividend expectation of 17 cents will likely see that yield fall to 4%, on a $4.30 purchase price.
But for that yield, the Telstra investor has experienced a 39% capital loss.
Investors in the big four banks have seen this downside, too, to the extent of share price falls of 16%–20% amid the maelstrom of the Royal Commission.
On current analyst estimates, collated by Thomson Reuters, the big four banks are trading on FY19 expected fully franked yields of 5.8% (ANZ), 6% (CBA), 6.5% (Westpac) and 7.2% (NAB), equivalent to grossed-up yields of 8.3%–10.3%.
But investors cannot be sure of how much of the Royal Commission reputational and penalty damage is already baked-in to the banks’ share prices, and they also have to reckon with a much tougher revenue and earnings growth environment for the banks, with the housing market definitely pulling back, the credit market cooling, and the added regulatory scrutiny tightening the banks’ lending criteria and adding costs to their businesses.
The upshot of these developments in the big four banks and Telstra is that income-focused investors no longer have easy choices on the stock market and need to broaden their search.
The good news is that there is no shortage of profitable industrial companies that appear to offer attractive and sustainable yields, with the ever-present caveat that share dividends can be cut by the companies, and even shelved altogether.
Here are four attractive yield scenarios from the smaller end of the industrial market.
Money3 (MNY, $1.92)
Market capitalisation: $317 million
Analysts’ consensus FY19 estimated yield: 5%, fully franked
Secured auto loans and unsecured personal loans company Money3 works with borrowers who are excluded from traditional lenders through a combination of circumstances such as being self-employed or having an impaired credit history. The company says its target market comprises 4 to 5 million Australians. Money3 specialises in lending for second-hand vehicles (mainly cars, but also vans, motorbikes and caravans). The company expects its reported FY18 gross loan book to be $307 million and predicts “significant growth” in its secured loan book in FY19. After making net profit of $29.1 million in FY17, MNY forecasts $31 million for FY18. The company is well-funded, with more than $40 million in reserves, and is strongly compliant with lending regulatory settings.
Adairs (ADH, $2.22)
Market capitalisation: $370 million
Analysts’ consensus FY19 estimated yield: 6.5%, fully franked
Homewares and manchester retailer Adairs (ADH) has rebuilt its credibility after being slashed 42% lower in value in a single day in November 2016 when it cut its full-year profit guidance. The stock sank from $2.57, before that disastrous downgrade, all the way to 62.5 cents in June 2017, before mounting a determined and disciplined recovery. Adairs lifted its first-half profit by more than 60% in the December 2017 half-year, to $13.9 million, and upgraded its full-year FY18 earnings guidance a second time in April, expecting “an FY18 result which sets new records in sales and earnings for the company.” On current analysts’ expectations as collated by Thomson Reuters, Adairs is potentially offering a grossed-up dividend yield of 9.5% in FY19.
Shriro Holdings (SHM, $1.15)
Market capitalisation: $110 million
Analysts’ consensus FY19 estimated yield: 8.3%, fully franked
Kitchen appliance and consumer products marketer Shriro distributes a range of brands, some on behalf of third parties, such as Casio watches, calculators and musical instruments, Blanco sinks and taps, and Pioneer stereo equipment, and also company-owned brands, which include Omega (kitchen appliances), Robinhood (kitchen appliances) and Omega Altise (coolers, heaters and air purifiers). The company is investing heavily in its own brands, especially the Everdure by Heston Blumenthal range of charcoal-fired barbecues, which it is taking to the US and European markets (most notably, Germany), in a strategy that could potentially generate good growth opportunities. Shriro saw its share price sold off in May by more than 11% after a trading update that projected a 15% slump in revenue, but the growth opportunity in the overseas business could see higher profits and dividends in coming years.
Virtus Health (VRT, $5.79)
Market capitalisation: $467 million
Analysts’ consensus FY19 estimated yield: 5.4%, fully franked
Reproductive services (IVF) provider Virtus Health is expanding out of its Australian base, where it is the largest provider, into markets such as the UK, Ireland and Singapore, and, Denmark, where the company announced last week that it has bought Trianglen Fertility Clinic in Copenhagen. Along with its clinic in Aarhus, Virtus now has a market share of about 15% of the Danish market. Virtus’ impressive steps to expand overseas should start to generate higher earnings and dividend flows from the stock, which is projected to yield 5.4% in FY19, or 7.7% grossed-up.
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