Who would benefit from franking’s fall?

Treasurer Joe Hockey’s recent comments heralding the end of dividend imputation have ruffled the feathers of fund managers and investors alike. In encouraging open dialogue about tax reform in the lead up to the federal government’s tax white paper, Hockey boldly announced franking would be placed on the table.

When introduced in 1987, dividend imputation acquainted many Australians with the share market for the first time and it continues to provide attractive but fair investment opportunities, particularly for self-managed superannuation funds (SMSFs).

A disaster in waiting

While there is certainly a case for improving the current imputation system, its removal would be a disaster. Its role in eliminating double taxation is fundamentally sound, and now that it has been operating for nearly three decades, it is vital for effective capital formation. I believe its removal would be political suicide.

Since the original announcement, Hockey has softened his language, but in the nature of open dialogue, let’s consider some high-yielding stocks that would survive double taxation.

Where should investors turn if the franking tap is turned off? It’s best to look for companies with a high, unfranked yield.

Companies with a high yield tend to have a higher payout ratio and outperform those with a low payout ratio and yield. This may seem counter intuitive, but if company managers must continually seek funding for projects, rather than dipping into their retained earnings, they’re more likely to invest in value creating projects.

Companies to consider if imputation goes

Currently, the companies with the highest payout ratios are those that also pay fully franked dividends, namely Telstra and the big four banks. Their fully franked dividends have attracted countless savvy SMSFs and pushed prices to record highs.

Without the incentive of fully-franked dividends, their natural replacement would be high-yielding companies that already pay unfranked dividends, primarily utilities and property trusts.

Some of these include:

• Scentre Group (SCG, yielding 5.7%)
• Stockland (SGP, yielding 5.3%)
• Sydney Airport (SYD, yielding 5.0%)
• Spark Infrastructure Group (SKI, yielding 5.8%)
• Transurban Group (TCL, yielding 4.5%)

The only high yielding stock we currently own is a property trust, Galileo Japan Trust (GJT), which yields 8.8% and trades at a 16% discount to its underlying assets. It is a higher risk play than traditional property trusts, with gearing (55%) against office and retail property assets in Japan.

Let’s hope this franking free scenario remains hypothetical. Wilson Asset Management will be making a submission to the federal Government outlining why we think dividend imputation should stay.

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 regards to your circumstances.