As interest rates crunch to records lows, the demand for “defensive income stocks” has taken some of the better known stocks to crazy prices. I thought the ASX (yes, that’s the listed company that runs the stock exchange) was a sell at $58 – it is now trading around $87, on a prospective yield of just 2.7% and 26.5% overvalued according to broker forecasts. Transurban, Sydney Airport, Coles, APA, Medibank and many of the property trusts are in the same situation.
So let’s look outside the top 50 stocks for some ideas. My idea of an “income stock” is that there needs to be a high degree of confidence that earnings (and the dividend) is sustainable; with a good track record; and importantly, relatively low capital risk. That is, if the market falls and/or the stock underwhelms, it will react less violently than the market. Obviously, a high dividend yield and franking are important but you can’t always have everything, particularly if you are putting any emphasis on capital stability.
Here are five stocks outside the top 50 to consider. I have thrown in a beaten up cyclical, a consumer discretionary and an energy stock, which certainly have some risk, so I have listed them in ascending order according to my assessment of “least risky” to “most risky”.
1. Viva Energy REIT (ASX:VVR)
Current price: $2.61; Broker target price: $2.51; Forecast yield 5.6% (unfranked)
Viva Energy REIT is Australia’s largest listed REIT (real estate investment trust) owning solely service station properties. Established in August 2016 as the owner of an initial portfolio of 425 service station sites, the property portfolio has subsequently increased to 454 sites. Largely ‘Shell’ branded, 75% of the properties are located in metropolitan areas, with 81% of the portfolio on the eastern seaboard.
The portfolio has a WALE (weighted average lease expiry) of 12.6 years (with virtually no expiries until 2026), 100% occupancy and 3% fixed rental increases. Like most property trusts, it is geared (currently around 32.3%). The management expense ratio is estimated to be 0.20% pa. In February, the REIT raised $100m through an institutional placement at $2.32 per security to finance 8 acquisitions and provide headroom for future growth.
It has guided to distribution growth in the range of 3.0% to 3.75% for FY19 (calendar year ending 31 December 19), which would see total distributions of 14.5c (a yield of 5.6%, unfranked).
While gearing is light and it is not overly exposed to interest rates, as a “bond proxy” type of stock, if interest rates rise, the unit price would likely fall. A rise in interest rates could also impact the capitalisation rates used to value the properties. The last reported net tangible asset value (NTA) is $2.20 per security.
2. Bapcor (ASX:BAP)
Current price: $6.22; Broker target price: $6.86; Dividend yield: 2.8% (fully franked), rising to 3.1% for FY20
Bapcor is Australia’s leading provider of aftermarket parts, accessories, equipment and services to the auto market. Through 940 locations across Australia and New Zealand, it operates in three business segments – trade, specialist wholesale and retail & service. While the retail arm is best known (with stores such as Autobarn), Bapcor generates 51% of its revenue and 53% of EBITDA by servicing the motor vehicle trade. Wholesale is next, with retail just 19% of EBITDA.
Bapcor boasts an impressive set of number as the following chart makes clear: NPAT and revenue growing at a CAGR (compound annual growth rate) in the high 30’s, earnings and dividends around 20%.
Bapcor – Revenue, NPAT, EPS and Dividends -2015 to 2019
Detractors argue that Bapcor, which is singularly focussed on the auto market, is running into two headwinds – a fall in new car sales, and in the medium term, the rise of electric vehicles (which require fewer parts and servicing). Bapcor argues that the overall car fleet is still growing (it rose by 2% in 2018), 60% of new vehicle sales are in the SUV and utility categories, and in regard to electric vehicles, it says that if electric vehicle sales reach 50% of new car sales by 2030 (in 2018 just 0.5%), only 7% of the whole fleet will be electric.
Bapcor has guided for full year NPAT to be around 9% higher than FY18 at circa $94.3m. Each of the major brokers has a ‘buy’ recommendation on the stack, with target prices ranging from a low of $6.31 to a high of $7.60. A final dividend of 10c would see the stock trading on a yield of 2.8%. Brokers see this rising to 3.2% in FY20.
3. The Star Entertainment Group (ASX:SGR)
Current price: $4.07; Target price: $4.82; Dividend yield 5.2% (fully franked) for FY19, 5.1% for FY20
This stock won’t suit some investors due to concerns about its casino businesses. The Star Entertainment Group is, of course, the operator of The Star Casino in Sydney, The Star Gold Coast and Treasury Brisbane. It is currently undertaking the Queen’s Wharf development project in Brisbane.
In June, the Star posted a trading update that warned of slowing domestic revenue growth. It said that full year normalised EBITDA would come in around $550m to $560m compared to $568m for FY18. However, the second half would be around $260m, a fall of about 7% on the same period. Star pointed to “more challenging macro-economic conditions across our markets”, lower hold rates on table games and the impact of disruption from capital works at The Star in Sydney. They also said they were accelerating cost saving initiatives.
The brokers thought that the trading update was “soft” and cut earnings forecasts. However, they still see the stock as undervalued with a consensus target price of $4.82 (range $4.04 to $5.60). In FY18, Star paid dividends amount to 20.5c, with brokers expecting Star to pay about the same (21.0c) in total for FY19 and again for FY20. This puts Star on yield of 5.2% (fully franked).
4. Viva Energy Group Limited (ASX:VEA)
Current price: $2.24; Broker target price: $2.49; Forecast yield 3.3% for FY19, rising to 4.2% for FY20
I didn’t get that excited about this stock when it hit the market as an IPO last July. Investors paid $2.50 for the shares and watched them trade as low as $1.80 in November when Viva missed its prospectus forecast.
Viva Energy was originally the downstream business of Shell Australia, before being spun out to an energy trading consortium and floated in 2018. It operates across two main business segments. The Retail, Fuels and Marketing segment consists of retail and commercial operations. In retail, Viva Energy supplies and markets fuel products through a national network of 1,165 retail service stations and sites (Coles Express, Shell & Liberty). In commercial, Viva Energy is a supplier of fuel, lubricants and specialty products to commercial customers and has a 37% market share in aviation fuels and 48% market share of marine fuels.
The second business segment is refining where Viva operates the Geelong refinery. The refinery supplies about 11% of Australia’s total fuel demand or approximately 50% of Victoria’s total demand.
It is in refining where most of the issues have been due to a material fall in the refining margin. For the 1H19, the underlying EBITDA from refining is expected to be broadly break-even. Retail and commercial has also been impacted, and while volumes are up by around 2% and in-line with the prospectus forecast, the retail margin has been squeezed due to the rising cost of oil.
Viva has guided to 1H19 (half year ending 30 June 19) underlying EBITDA of $150m to $180m (this compares to a prospectus forecast of around $340m).
But the brokers see upside with Viva, noting that refining offers potential for significant upside in the medium term, and that Viva is winning market share in retail and commercial. Viva has a strong balance sheet and favourable valuation. Targets range from a high of $3.10 for Macquarie down to a low of $2.07 from Morgans.
For FY19 (calendar 2019), the brokers expect Viva to pay fully franked dividends of about 7.5c per share (3.3%), before rising to 9.5c per share for FY20 (yield of 4.2%).
5. Adelaide Brighton Limited (ASX: ABC)
Current Price: $4.35; Broker Target Price: $3.88; Forecast Yield 5.1% (fully franked) for FY19 and FY20
Construction materials and lime producer Adelaide Brighton has had a tough last 12 months, falling from a high of $6.80 in August to a low around $3.50 in May following a profit downgrade.
Adelaide Brighton manufactures and supplies products to the building, construction, infrastructure and mineral processing markets. This includes the production, importation and distribution of clinker, cement, industrial lime, premixed concrete, aggregates and concrete products.
32% of ABC’s revenue comes from the engineering and infrastructure construction segment, 32% from residential construction, 22% from non-residential construction and 14% from the mining industry (lime is used by gold producers and others).
In May, ABC said that it expected underlying net profit for FY19 (calendar 2019) to be 10% to 15% lower than FY18’s profit of $190.1m. It blamed “softening demand for construction materials in the residential market, increased competition from cement imports, increased competitive pressures in Queensland and higher costs for key raw materials”.
The brokers were quick to downgrade ABC, but have since noted that the outlook for residential construction has improved following the Coalition’s surprise election win, two rate cuts by the RBA and APRA’s easing of lending restrictions. That said, they are still nervous, with the consensus target price of $3.88 some 10.8% below the last price. Of the six major brokers who cover the stock, there is 1 buy recommendation, 2 neutral recommendations and 3 sell recommendations.
The current consensus forecast is a full year dividend of 22c (fully franked) for FY19 and FY20, which puts the stock on a yield of 5.1%. Some brokers have the dividend at 19c, and with a new CEO (Nick Miller started in February) and a new CFO on board, there is a bit more risk on this stock at the moment.
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