Brokers Highlight Need For Growth Beyond Dividends

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This story features FORTESCUE LIMITED, and other companies.
For more info SHARE ANALYSIS: FMG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Need for both dividend and growth
-Small cap industrials outlook improves
-Dilemma of high price/earnings ratio
-Housing exposure versus resources
 

By Eva Brocklehurst

The latest data, according to Credit Suisse, shows Self Managed Super Funds (SMSFs) own 16% of the Australian equity market and have been allocating money to stocks from cash. Credit Suisse suggests that because SMSFs are primarily looking for income, they could be distorting corporate capital allocation decisions. The growing importance of this type of superannuation fund is a reason, in Credit Suisse's view, why the dividend trade has performed unusually well and will continue to do so.

Credit Suisse observes the lack of a credible bond market in Australia means SMSFs are focused on income when buying equities and they have little appetite to finance future growth. As this investor base is a fair size, the broker is hesitant to be a seller of a stock that continues to provide yield and dividend growth. Credit Suisse is a buyer of those stocks with reasonable dividend yields but also those growing yield at a solid rate. Companies that present well on both factors include Fortescue Metals ((FMG)), Macquarie Group ((MQG)) and Sonic Healthcare ((SHL)). Those where the dividend outlook is poor and cash flow cover is limited include Qantas ((QAN)), Crown Resorts ((CWN)) and Metcash ((MTS)).

The broker likes the fact that SMSFs make companies think harder about allocating capital, a positive for productivity. Still, that comes at a cost to growing the productive capital base and providing more employment, as well as helping the economy to re-balance away from mining investment. Credit Suisse analysts have compared the success of high yield investing, as it is now, with the similar stages in past equity market cycles and have found that it is unusual for dividends to perform as a factor this far into a recovery. Perhaps, SMSFs are one of the reasons why. The broker hastens to add that high yielding stocks are not about to collapse, but it is dangerous to have a singular focus. Dividends can be cut, Credit Suisse reminds us. Ahead of the GFC the European and US banks were yielding over 10% and we all know what happened after that.

Citi observes the bottom of downgrade cycle for small cap industrials has likely passed. The last reporting season was considered relatively good, with few negative surprises. The broker now rates the top three Buy calls as: NextDC ((NXT)), which has considerably de-risked its business model, has completed its domestic data centre footprint and is now focused on actively utilising its five assets; Amcom ((AMM)), for which the fibre business remains robust and earnings are growing strongly; and Hills Holdings ((HIL)) which, having divested its steel assets will be re-allocating the funds into low-capital intensity, high margin businesses.

UBS notes the dilemma for many is that the industrials sector, ex financials, is trading on 17.2 times 1-year forward earnings. This price/earnings ratio (P/E) is 13% above the long-term average. The broker thinks the rate can improve in FY15 as economic growth picks up. The detail on individual stocks probably matters in this case and UBS suspects the more respectable aggregate market P/E of 14.3 times is stemming from a low rate for the mining sector, which is trading on 11.5 times, more than 10% below its long-term average. Moderate P/Es for non-bank financials such as insurance, real estate investment trusts and diversified financials are also probably pulling the overall market back towards average.

The broker thinks concerns about the the high P/Es in industrial stocks are mitigated, somewhat, by low bond yields and the still-high Australian dollar as well as some cyclical earnings recovery in those comapnies exposed to the US and domestic economy. The industrials, ex financials, grew at 3.5% in the December half, notably dragged lower by the poor profit performance at Qantas.

UBS discerns that conditions are getting better for those stocks exposed to housing construction and worse for those exposed to resource capex. Hence, Boral ((BLD)), Stockland ((SGP)) and Harvey Norman ((HVN)) are held in the broker's model portfolio in respect of this scenario, and DuluxGroup ((DLX)) has been added. Beyond this, conditions are more stock specific. UBS observes the market is increasingly bidding up a small number of mid cap and small cap growth stocks. Hence the broker is underweight this cluster, which includes SEEK ((SEK)), REA Group ((REA)), Carsales.com ((CRZ)) and Navitas ((NVT)). Instead, UBS prefers to focus on more reasonable price growth in CSL ((CSL)), ResMed ((RMD)) and Aurizon ((AZJ)).
 

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