With the Reserve Bank of Australia (RBA) holding the official cash rate since May at a record low of 2%, the attractiveness of term deposits is waning rapidly. According to research firm Canstar, about the best an investor can do in term deposits at present is 2.9% for a one-year investment and 3% for a two-year rate.
If income is your investment focus, that is a paltry return, and investors are voting with their feet. Term deposits have been regularly falling in annual terms for 23 months – the longest period in records going back almost 30 years.
So where do investors look for yield? Increasingly, the share market.
According to Macquarie, the S&P/ASX 200 stocks offer investors an average prospective (FY16) dividend yield of 4.5%. If fully franked, that average yield would equate to a grossed-up yield of 6.4%. Compared to term deposit returns, that is a very attractive yield. The problem is that equity dividends come out of company earnings, and are not certain in any financial year.
This is particularly relevant if investors assess stocks on the basis of their prospective, or estimated (or “forward”) earnings, using their broker’s (or analysts’ consensus) forecasts dividends. Forecast earnings – even consensus – are only opinions until they are paid. Even if you assess yields using the last reported dividend – which is at least fact – it is only realistic if the company can at least match that dividend. At any time, investors looking at relatively high dividend yields on offer in the stock market have to consider the possibility of earnings downgrades.
The other aspect of share dividend yields that must be borne in mind is that they move inversely to the share price: meaning that sometimes, a rising yield tells you that the market expects the dividend to be cut. Or, looked at another way, that a high yield indicates distress. When you’re investing in shares for income, you have to be confident that the companies can pay the dividends when they’re supposed to.
With those caveats understood, some of the industrial stocks in the S&P/ASX 300 Index offer prospective yields above even those of the major banks – but the banks and Telstra are the main havens for yield-seeking investors.
Bank stocks
The big four banks have largely replaced term deposits as the most favoured place for retail investors to generate yield, for the simple reason that the banks’ dividend yields are more than twice as high as the returns they offer depositors.
On FN Arena’s collation, the analysts’ consensus expects ANZ to pay a dividend of 182.9 cents a share in FY16, rising to 185.5 cents in FY17. At the price of $26.015, ANZ is on a FY16 yield of 7%, rising to 7.1%. On a fully-franked, grossed-up basis those yields equate to 10% (FY16) and 10.1% (FY17).
Commonwealth Bank (CBA) is forecast to pay a dividend of 426.1 cents a share in FY16, followed by 433.1 cents in FY17. At $77.88, that puts CBA on a FY16 yield of 5.5%, moving to 5.6% for FY17. On a fully-franked, grossed-up basis those yields equate to 7.9% (FY16) and 8% (FY17).
National Australia Bank (NAB) is expected to pay a dividend of 198.9 cents a share in FY16, followed by 200.3 cents in FY17. At $28.22, that puts NAB on a FY16 yield of 7%, increasing to 7.1% for FY17. On a fully-franked, grossed-up basis those yields equate to 10% (FY16) and 10.1% (FY17).
In the case of Westpac(WBC), consensus forecast dividend payments of 190.8 cents in FY16 and 194.8 cents in FY17 imply, at the share price of $31.03, prospective yields of 6.1% (FY16) and 6.3% (FY17), fully-franked, grosses-up to the equivalent of 8.7% and 9% respectively.
So that is a nominal yield range for the major banks for FY16 of 5.5%–7%, and 5.6%–7.1% for FY17. No wonder that investors increasingly prefer to be paid as shareholders than as depositors – particularly given the tax-effectiveness of fully franked dividends within self-managed super funds (SMSFs).
The banks have responded to demand from investors – particularly SMSFs – to increase payout ratios (the proportion of profit paid out as dividends), which have been rising since 2011. Broker Morgan Stanley reckons that ANZ’s payout ratio, at 71%, is already above its target band of 65%–70%, and is at its highest level since 2008. NAB’s payout ratio is 74%, while CBA and Westpac currently pay out 75% of earnings as dividends.
This is despite increased capital requirements put on the banks by the regulator, Australian Prudential Regulation Authority (APRA) – in line with global bank regulation – and recent declines in bank returns on equity. Morgan Stanley does not believe the banks’ payout ratios are sustainable at this level: if bad debts begin rising again, which virtually all bank analysts factor-in, Morgan Stanley suggests all four major banks would have to review their dividends. The broker warns that “the probability of dividend cuts is rising.”
Telstra
The telco giant has also been a yield stalwart, as it kept its 30- cent annual dividend intact for many years, before increasing it three times in the last two years. With rising profits and millions of customers, Telstra is seen as the equal of the big four banks as an income generator.
On FN Arena’s collation, the analysts’ consensus expects Telstra to pay a dividend of 31.7 cents a share in FY16, rising to 32.9 cents in FY17. At the price of $5.21, that prices TLS on a forecast FY16 yield of 6.1%, rising to 6.3% in FY17. On a fully-franked, grossed-up basis those yields equate to 8.7% (FY16) and 9% (FY17).
Big miners
At first glance, commodity producers are not the best candidates for a yield portfolio, as their profits – and thus dividends – are highly cyclical, exposed to the vagaries of both commodity prices and exchange rates.
But in the last decade, the big Australian-listed global diversified miners, BHP Billiton and Rio Tinto, have both committed to a “progressive” dividend policy, under which – their dividends will always increase in US dollar terms (the currency in which they report.) This was highly lucrative for shareholders through the China-inspired commodity boom, but this year, analysts say both BHP and Rio Tinto will need to borrow to lift their dividends. In August, Rio Tinto admitted to using debt to deliver a 12% boost to its interim dividend despite a sharp slump in commodity prices and earnings, in a move than has seen the miner’s net debt rise over the past six months.
FN Arena has the consensus analysts’ expectation that BHP will pay a dividend of 120.3 US cents in FY16, decreasing to 116.9 US cents in FY17. On present exchange rates, that would equate to a yield for an Australian investor of 10% in FY16, easing to 9.7% in FY17. Fully-franked, those yields gross-up to 14.3% and 13.8% respectively.
For Rio Tinto, the analysts expect dividends of 220 US cents in 2015 (Rio Tinto uses the calendar year as its financial year) and 224.9 US cents in 2016. On present exchange rates, that represents to an Australian investor a forecast yield of 7.2% in 2015 and 7.4% in 2016, or fully-franked, grossed-up to 10.3% and 10.6% respectively.
As if the commodity price/exchange rate picture was not uncertain enough, both these companies have global shareholders known to be unimpressed with the progressive dividend policy, preferring reinvestment in the business. BHP is already making noises that the policy was never meant to be permanent: shareholders of this pair are on notice that dividend projections cannot wholly be relied upon.
Real Estate Investment Trusts (REITs)
The sector formerly known as property trusts has also traditionally been a favourite of yield-conscious investors, given that the REITs pass on the vast bulk of their rental income to investors. There is no franking, but there can be a small tax-advantaged component, arising from tax concessions such as depreciation allowances and tax-deferred income, which is not as effective in reducing an investor’s tax liability as fully franked dividends from shares – and in the SMSF context, does not give any augmentation of the yield to the SMSF in accumulation or pension phase.
However, local investors continue to like the average distribution yield in A-REITs, which is running at about 5.1%, according to Macquarie, down from about 6.5% in 2013.
Here is how analysts view the upcoming distribution yields of some of the top-rated REITs, according to FN Arena:
Another popular yield investment is the listed ‘hybrid’ securities market (so named because the securities are a mix of debt and equity). Most of the listed interest-bearing securities are floating- rate securities, which offer a yield that is based on a margin over the bank bill rate.
The vital statistics in the hybrid universe are the running yield, the income yield paid annually, and the yield to call, which is the investor’s expected return assuming all distribution payments are made through to conversion, and assuming that investors realise the face value of the security and fully use any franking benefits. Courtesy of broker Morgans, here are its ten most reliable hybrid yields for FY16.
The attraction in hybrids is that they pay considerably more than you can earn in a bank term deposit, and assuming you hold them to the anticipated redemption date/maturity, you should get the face value that you paid at IPO back. In other words, the attraction is a ‘secure’ capital and income.
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.
