A New Market Tool For ‘Risk’

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

In this week's Weekly Insights:

– A New Market Tool For "Risk"
– ANZ Bank: Between Rock And Hard Place
– Who's Afraid Of The Gold Bugs Index?
– At The Stockbroker's Awards
– No Weekly Insights Next Week
– Rudi On TV
– Rudi On Tour

A New Market Tool For "Risk"

By Rudi Filapek-Vandyck, Editor FNArena

I have written about this before. Certainly, if you have attended one of my presentations this year you would be well aware of the fact dividend yields have converged across all sectors on the Australian share market.

To the point that if you happen to pay a sizeable dividend to shareholders, and the share market believes that what you are doing is reasonably sustainable and reliable, then your share price has reset to a level whereby the implied forward looking yield is now somewhere in between 4 and 6%.

This can lead to unusual observations, such as that BHP Billiton ((BHP)) now appears to be promising a far better yield than any of the Big Four banks in Australia.

On most calculations, BHP's forward yield is still in the vicinity of the sub-6% that is also on offer through the likes of ANZ Bank, National Australia Bank and Westpac (and equally 100% franked too).

However, with the Aussie dollar taking a dive in recent days on the back of Grexit fears, the immediate, direct translation of future BHP dividends paid out in USD has lifted to no less than 6.4%.

Go figure.

By the way, FNArena is to my knowledge the sole service available in Australia, maybe even worldwide, that instantaneously calculates forward implied yields from consensus forecasts for foreign currency stocks such as BHP, QBE Insurance and Woodside Petroleum at present AUD value.

Incidentally, forward implied yields for QBE and Woodside are 4.0% and 4.1% respectively, further adding to my yield convergence observation. Both yields are also predicted to rise significantly in 2016, suggesting there's upside in store for these share prices.

Before we dig deeper into the finer details, let's reminisce first about the convergence that has taken place on the back of the final leg in the world's greatest bull market for government bonds, ever.

Charts Tell A Thousand Words

The first chart has featured earlier, but I think it's worthwhile repeating: observe the convergence across all segments and sectors (thanks Citi).

The second chart essentially shows the same process through examples of a few iconic ASX-listed stocks:

Finally, the table below comes from Macquarie's update on the Australian share market. Observe how average yield from resources stocks now remains in line with the broader market, but also that banks, when it comes to yield, remain head and shoulders above the rest of the market. The latter is one observation worth keeping in mind inside today's context for income-hungry investors amidst global threats and uncertainties.

So 4-6% has become the new bandwidth to judge dividends and yield on the Australian share market. With regards to the stocks I mentioned, this seems to make a lot of sense. Both QBE and Woodside trade closer to the bottom of the range because there seems to be a lot of upside potential in twelve months from today. BHP, on the other hand, is facing a lot of pressure on cash flow and one would have to be very bullish on base metals and on bulks to completely dismiss the idea that the board might, just might, reconsider its progressive dividend policy.

Among the banks, CommBank's implied yield sank to circa 4.5% earlier this year, but that was before investors were being reminded this is a low growth environment for Australian banks too, and China looks quite frightening at times, not to mention European banks, wholesale funding, increased regulatory requirements, a super hot Sydney property market and the likely need for additional capital in the years ahead. The banks have responded by starting to sell non-core assets.

Below are a dozen ASX-listed stocks, chosen tabula rasa (at random), revealing how little difference there is left in yield when one looks at the ASX through mainstream eyes:

– Wesfarmers ((WES)) 5.5%
– Harvey Norman ((HVN)) 5.9%
– Stockland ((SGP)) 5.8%
– Telstra ((TLS)) 5.0%
– ASX ((ASX)) 4.6%
– Super Retail ((SUL)) 4.3%
– AGL Energy ((AGL)) 4.0%
– Mirvac ((MGR)) 5.0%
– Challenger ((CGF)) 4.4%
– Santos ((STO)) 4.5%
– Alumina Ltd ((AWC) 5.4%
– Energy Developments ((ENE)) 5.5%

I am sure in most cases we can all come up with reasons as to why a certain stock yields 4% against another at 5% and higher. We can even start making considerations whether in some cases it wouldn't be better to opt for 4% instead of 5% or higher, since there is more growth/sustainability attached to it?

Why The Premium?

Growth, reliability, sustainability and predictability/past track record all play an active contribution as to why certain stocks are no longer offering a yield inside the 4-6% range.

Take Amcor ((AMC)), for example. Past observations taught me an ideal moment to start accumulating shares was whenever the forward implied yield rose to 4.5%. Perfect! However, today the shares are offering 3.5% on FY15 consensus estimates, only rising to 3.7% on FY16 forecasts.

Clearly, the market has now granted Amcor shares a premium following the impeccable performance in years past. It'll take a big accident, a sudden profit warning or all-hell-break-loose experience in the share market to push Amcor shares back into the 4-6% yield range.

In similar vein, Lend Lease's ((LLC)) implied yield for FY15 has now fallen to 3.5% but investors are arguably already concentrating on prospects for FY16. On that basis, the implied yield is 4.3%, still inside the range. (Let the big jump in yield be a signal that analysts are anticipating a major jump in dividends next year).

Of course, there are a large number of stocks currently trading on below-range yields, like Ansell, and ResMed, and Qantas, and Oil Search, but these stocks have never traded on yield and they seem to have enough growth options under their belt to stave off a de-rating a la BHP Billiton, Woodside Petroleum or Rio Tinto, to pull their yields inside the 4-6% range.

Investors should never forget that, underneath all the other characteristics that can make investing in the share market an exciting and interesting journey, is the ironclad law that growth rules and growth tops anything else in the share market. Thus even during times when so many investors' focus seems to be on yield and income, companies on low yield (or no yield) are still measured on growth.

I can easily put up an argument that this also holds true for the companies whose implied dividend yields are inside the 4-6% bandwidth. It's why BHP Billiton does not yield 4% and why AGL Energy does.

It does not work for Santos, however, whose yield would be much, much, much lower than the current implied 4.5% if only investors would have more confidence in its balance sheet, future cash flows, debt reduction and project execution in a lower-for-longer price environment.

A New Yardstick For "Risk"

My concern goes out to the many investors, and their advisors, who have as yet not caught up with the market's convergence in the 4-6% yield range. Imagine telling your advisor you need income, now, because the term deposit is no longer providing it.

4% doesn't sound like an exceptionally good deal. 6% probably does. That's the present territory of three major banks, ex-franking, as well as BHP Billiton, Flexigroup, AusNet Services and Ardent Leisure, to name a few. Beware for the smarty pants advisor who just happens to have a hidden gem yielding 7% or more.

One will never ever hear me say the share market is always efficient under all circumstances (it definitely is not), but the market is usually very good in distinguishing the fakers from the real McCoys, given enough time. As such, one would have to question why a particular stock is trading on an implied yield well outside the 4-6% range.

Is it maybe because the risks involved are too high for comfort?

Under the current circumstances, I would argue stocks on implied yields of 6% already are among the riskier ones. Which is why searching for 7% via the Sentiment Indicator on the FNArena website generates names such as WorleyParsons, Cardno, Cromwell Property Group and Myer.

7% doesn't sound like a lot more than 6%, but I think it's only fair to say investors should take guidance from the 4% that is the bottom of the range. Those stocks are the safest yield plays in the market. Growth and reliability are reflected in that bottom of the range yield. Everything else is one step up in risk.

6% represents quite a number of higher levels of risk added. Everything beyond… (you get the picture, I am sure).

What About BHP And RIO?

A low oil price environment. A low coal price environment. Unfulfilled potential for copper, which remains a long term growth story. No light at the end of the tunnel for aluminium. A persistent downtrend for iron ore.

Clearly, things have not worked out according to plan for management and the boards at global resources giants BHP Billiton and Rio Tinto ((RIO)). To add insult to injury, analysts taking an in-depth look into their numbers and calculations can only draw one solid conclusion: it's going to be tough to maintain progressive dividend policies. It is well possible companies might have to take on debt if they don't want to renege on their promise to shareholders.

Of course, things can change suddenly and quickly when prices for base materials are beaten down to levels below 2009's, but few would dare to put their neck on the block together with the prediction the second half of 2015 will look significantly better. As things stand right now, it appears most analysts would only be willing to take a bet on 2016, maybe on the second half of 2016?

One quick glance at current consensus forecasts shows no relief in sight for BHP Billiton which, if current projections prove correct, will have experienced three truly horrible years out of the past four with major declines in profits yet again by the end of FY16. Rio's numbers are anticipated to look truly horrible when it reports 2015 number in February next year, but things should improve throughout 2016.

Look no further as to why both share prices are now offering yields towards the ceiling of the 4-6% yield range; in the absence of growth, there is but yield, but it doesn't come without risks.

Maybe the good news is that yields for both global diversifieds are still within the range, far below what shares in companies like MMA Offshore (15.5%), Monadelphous (10%) and Seven West Media (10%) are trading on.

ANZ Bank: Between Rock And Hard Place

Australian banks are under pressure to strengthen balance sheets in the face of increasing regulatory requirements. Already, we've seen the board at National Australia Bank ((NAB)) biting the bullet and (finally) divesting the UK operations while launching the largest capital raising ever in the history of Australian finance. Westpac sold part of its equity in listed BT Investment Management ((BTT)).

Next one up could be ANZ Bank ((ANZ)) with analysts speculating the board is looking into selling off minority interests in Asia. That should temper market concerns about the potential requirement for extra capital.

At least for the short term, say analysts at Macquarie. They see a few niggling problems further down the track though, in that selling Asian equity may also lower Return on Equity (RoE) for the group as a whole, plus it'll reduce the earnings contribution from the Great Asian Expansion Strategy.

All in all, thinks Macquarie, that target of deriving 25-30% of total revenues from Asia by 2017 looks more than just a tad ambitious now. The real pressure, however, is on for the dividend. Macquarie analysts calculate the payout ratio could potentially lift to 80% if and when Asian equity goes out the door and thus would have the board rethink "sustainability".

No surprise thus, Macquarie sides with analysts who have a more sedate price target, in the vicinity of the present $32-33 instead of the $39 suggested by stockbroker Morgans. The lowest on file here at FNArena is Morgan Stanley with a twelve month target of $30.90.

Who's Afraid Of The Gold Bugs Index?

Local gold producers, at least some of them, showcased an absolute cracking performance in the opening months of the new calendar year, but things have turned a lot quieter post April. With Putin and Greece and IS dominating global headlines, this seems a bit odd, don't you think?

Not so if you believe the US Fed is the real gorilla in the gold candy shop, as I do. In that case a lot of the week-to-week mysteries that surround gold's market movements make a lot more sense if it's interpreted against the all-encompassing background question of: how is this possibly going to influence the timing and pace of US interest rate hikes?

The question about what next for gold, and for gold producers, becomes a lot more intriguing when faced with the chart below.

According to recent analysis done by Citi analysts, gold producers worldwide are still grasping for oxygen, finding it incredibly tough to stay profitable at sub-US$1200/oz levels.

The chart above was grabbed from Chart of the Day and the commentary on it leaves little room for misinterpretation. One thing's for sure: combine prospects for a different trend in US interest rates and bond yields with Citi's research and that chart, and it's potential implications, start making a whole lot of sense.

(Watch this space post the Grexit-inspired revival).

At The Stockbroker's Awards

Forgot to include this in last week's edition, Julia Lee and the tech team at Sky Business set up shop inside a hotel in Sydney CBD to broadcast a special edition of Your Money, Your Call Equities at the fringes of the annual Stockbrokers Awards. Your Editor participated too, but you'll have to wait until the final segment (last 12 minutes) to witness my contribution to questions about China and what stocks everybody should have in portfolio:

https://www.youtube.com/watch?v=2BpMXfWjGp0&feature=youtu.be?

No Weekly Insights Next Week

I'll be hibernating in hopefully a little warmer environment next week (Sydney is experiencing near freezing temperatures in July), researching and writing my current work-in-progress. If you are a paying subscriber, this will be yet another bonus that comes your way, once it is finished. Watch this space.

(I will still be involved, just not writing the Weekly Insights while TV and public appearances are off for the week too).

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Thursday, Sky Business, noon-12.45pm, Lunch Money

Rudi On Tour

I have accepted invitations to present:

– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

http://www.investors.asn.au/events/events-schedule/aia-national-investors-conference/

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Monday, 6 July 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today's share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of June available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms