Deep-value or contrarian investing requires an intense focus on company valuation, high conviction and, most of all, patience. Even great investors rarely pick the absolute bottom with turnarounds. You have to be prepared for further volatility – and have a strategy to capitalise on it. Turnarounds usually take time. Sometimes it takes years for a struggling company to restore market confidence and years again for a stock to become overvalued as the bulls return, late to the party.
Markets move much faster than companies. It takes time to implement new strategies, sell assets, change management and overcome cyclical and structural industry factors. Turnarounds are hard work. That’s why many disappoint or fail. I favour turnaround situations where I’m paid to wait. That is, the company has an attractive, reliable, fully franked yield that compensates you along the way.
Getting a 7-9% fully franked dividend yield for a quality, undervalued company means you can wait for a recovery without sacrificing overall portfolio returns. The key, of course, is finding companies with reliable dividend outlooks. Struggling companies often cut their dividend because their earnings are low, or they have to reinvest more capital into the business to fix it.
Chosen well, the potential is owning companies that lift the dividend as their earnings recover. Or they buy back their undervalued shares, reducing the number of issued shares and supporting earnings-per-share growth. Some corporate turnarounds lift their dividend payout ratio to compensate long-suffering shareholders through a higher yield.
Getting paid to wait for a recovery has other benefits. First, there’s more time for corporate predators to swoop and drive the price higher through a takeover. Second, owning undervalued companies reduces portfolio risk. There’s less valuation downside because so much bad news is already priced in. Owning stocks that trade well below their intrinsic or true value means having a larger margin of safety for inevitable problems with turnaround strategies.
Although this sounds good in theory, it’s harder to do in practice. Quality companies trading well below their true value – and offering an attractive, reliable, fully franked yield – are not easy to find. If they were, the opportunity would quickly fade.
Here are two stocks that, at their current price, pay investors a decent yield as they wait for the share price to recover:
1. Woodside Energy Group (ASX: WDS)
Readers know I like the prospects for the energy sector, principally on emerging supply constraints that will underpin the commodity super cycle this decade.
Heightened focus on Environmental, Social and Governance (ESG) issues has affected investment in new fossil-fuel projects and extensions of existing ones. I respect ESG investors, but coal and oil stocks look interesting.
I suspect energy could be one of the better-performing sectors in 2025. US President-elect Donald Trump’s promise to ‘drill, baby, drill’ shows the United States’ renewed vigour for fossil-fuel extraction and cheap, reliable energy to power its economy.
In Australia, Woodside Energy shares have fallen from a 52-week high of $33.08 to $24.75, in a rising share market. A lower realised price for oil equivalent (BOE), production challenges, surprise acquisitions and regulatory hurdles have weighed on Woodside. The stock traded around $38 just 14 months ago.
At the current price, Woodside is yielding about 9% fully franked, courtesy of an 80% dividend payout ratio. Some brokers expect the payout ratio to fall next year (the official policy is maintaining at least a 50% payout ratio). That’s an example of being paid to wait for a share-price recovery. Even the dividend comes back a little in FY26, it’s still attractive.
On valuation, Woodside trades on a forward Price Earnings (PE) ratio of 11.5 times, based on the consensus analyst forecast.
Woodside has an extensive development pipeline, and some big projects recently commissioned or coming on stream by 2026. Woodside should have more tailwinds in the next few years to support its recovery and reverse its underperformance against the S&P/ASX 200 over one year.
Longer-term, Woodside will benefit from rising gas demand in Asia, which is the key input in the region’s energy system and far less carbon-intensive than coal.
Morningstar values Woodside at $40 a share. I’m not as bullish, but agree the stock is undervalued at the current price and should deliver a solid fully franked yield for patient investors who can wait for a recovery this decade.
Chart 1: Woodside Energy Group
Source: Google Finance
2. Aurizon Holdings (ASX: AZJ)
The Queensland-based rail operator has fallen from a 52-week high of $4.07 to $3.37. In 2019, Aurizon traded at almost $6 a share.
Around 80% of Aurizon’s Earnings Before Interest and Tax (EBITDA) still comes from bulk haulage of thermal and metallurgical coal in Queensland and New South Wales. That’s big leverage to a commodity that will be used less in coming decades as economies decarbonise.
Aurizon is working hard to diversify its revenue stream by expanding its bulk freight operations and reducing its reliance on coal. But the market is unhappy with the speed of progress, judging by Aurizon’s sagging valuation.
At its current price, Aurizon is expected to yield about 5.5% after partial franking. That’s a solid (though not spectacular) yield and should be reliable given Aurizon’s long-term contracts in long-haulage coal operations.
On valuation, Aurizon trades on a forward PE ratio of about 14 times based on the consensus forecast. That’s not overly demanding for a transport operator that is a key player in coal haulage and has a growing bulk freight operation.
Aurizon has had its fair share of disappointments and has underwhelmed the market for too long. Like or loathe coal, the reality is there’s still plenty of demand for it from Asia and a decent outlook for Australian coal exports.
Recovering volumes in coal exports, and modest margin expansion due to efficiency gains and better asset utilisation, should aid Aurizon in the next few years.
The stock is no world-beater, but its yield and attractive valuation – relative to other transport stocks – appeal for patient investors who can wait for a recovery.
The market is too bearish on Aurizon at its current price and too bearish on the outlook for coal exports. There is still a lot of life left in bulk coal haulage.
Chart 2: Aurizon Holdings
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 4 December 2024.
