Scott Kelly
With the recovery in dividends underway, it is important for investors selecting shares for an equity income portfolio to keep in mind that they need to choose stocks that are likely to pay a growing dividend over time and not just those stocks with a current high yield, according to DNR Capital, a leading Australian equities investment manager.
Scott Kelly, Portfolio Manager for the DNR Capital Australian Equities Income Fund[1], says: “The recent reporting season was one of the best we have seen in terms of companies delivering results ahead of analysts’ forecasts, and with operating conditions improving across a number of sectors, boards have started reinstating more generous dividend payout ratios.
“Some companies currently paying high dividend yields may actually have low, or even negative earnings growth going forward. This will limit future dividends and will likely impact their share price too. It is important to be aware of these dividend traps.
“Pursuing a high-yield strategy, while ignoring other factors, is simplistic and fraught with danger. High yields can indicate companies are facing structural headwinds and dividends might be at risk of being cut,” says Kelly.
The DNR Capital Australian Equities Income Fund seeks to identify quality medium to long-term investments delivering sustainable, growing income. The Fund seeks to invest in a selection of securities that have sustainable dividend capability, strong profit-to-cash conversion and relatively assured earnings growth.
He adds: “Assessing a company’s dividend sustainability is core to our Income Fund. We look for quality companies that can demonstrate the ability to sustain and grow dividends over time.”
“This year we have added logistics services company Qube Holdings to the Fund’s holdings. The current yield is relatively low but the outlook for dividend growth is very strong.
“We consider Qube one of the most visionary and well-managed businesses in the ASX 200. It is in the process of selling warehouses and property at Moorebank in Sydney, and assuming successful completion of the sale, the company’s strong balance sheet should allow accretive corporate activity.
“The company’s forecast dividend of 6 cents per share for the 2020/21 financial year represents a yield of around 2 per cent, fully franked. However, we expect double-digit growth over the next three to five years. In addition, we estimate Qube will have excess franking balances that would allow it to pay a special dividend of up to 15 cents per share.”
Financials have led the way in the dividend recovery, accounting for close to half of all ASX200 dividend upgrades in February.
“But we remain cautious about the role of bank stocks in our strategy. We added Westpac Corporation but retain an underweight of around 6 per cent to the Big Four Banks. Rising interest rates and lower bad debt provisions have been better than expected. Operating trends have also been positive, with net interest margins beating expectations and solid cost control evident.
“Higher bank dividend payout ratios and capital management appear attractive for income-seeking investors. However, long-term headwinds remain for the sector, including disruption from fintech companies.
“Our preferred banks remain NAB and ANZ. We have no holding in Commonwealth Bank on valuation grounds.”
The DNR Capital Australian Equities Income Portfolio has a dividend yield expectation of around 4.5 per cent for 2021, which is almost 6 per cent if grossed up for franking credits.
He notes: “This is clearly very attractive relative to alternative investments in the current environment.”
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