The Understated Comeback Of Aussie Dividends

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

This February reporting season is expected to feature dividends re-emerging from a serial downturn that started two years ago and accelerated with the pandemic, leading analysts to hunt for stocks likely to surprise

-Dividend outlook possibly understated, so look for surprise announcements
-Expect above average dividends by the major miners
-Major banks expected to increase dividend payout ratios
-Risks to Energy and Telcos

By Mark Story

Given the recent good form experienced by the ASX200 index, up 47% since the 23 March low, there’s growing optimism that stronger-than-expected profit results this reporting season will see an end to the run of declining payouts of dividends over the past year or more.

Notably absent over the past two years were the historically high dividends paid by the big four banks, with many retirees who typically live off bank (and other) dividends, regarding secure yield as critical.

While the coronavirus didn’t do any favours to company distributions, the number of companies with the capacity to pay a sustainable dividend was on the wane well before the pandemic surfaced.

Over the past nine months, dividend deferrals and cuts have taken a considerable toll on income investors with the forecast 12-month forward yield of the ASX200 shrinking below its 10-year average of 4.7% to 3.4%.

During 2020 the earnings payout ratio also reduced from 73% to a low of 65%.

The ice is melting

With 13 of the 15 local companies that have reported in February thus far (up until Monday, February 9), having hit or exceeded expectations, and forward guidance from companies operating under robust operational momentum, there is growing expectation the recent freeze in company distributions could finally start to thaw.

There’s no expectation of a dividend bonanza any time soon, and yields aren’t expected to return to average over the short term, with FY23 market estimates, including FY23 dividend estimates, still lagging pre-covid-19 levels by almost -20%.

However, Wilsons suspects the market is potentially understating the dividend outlook.

With the payout ratio for the market as a whole falling from 84% to 65%, the broker suspects corporates are awaiting higher confidence around the outlook before deploying the cash on corporate balance sheets into growth initiatives, and/or higher dollar dividends.

While earnings have been revised upwards, with economic outcomes not as bad as feared, Wilsons argues that dividend estimates have lagged along with capital management initiatives, which are also typically poorly forecast, offering an additional source of dividend payments.

Greater expectations

Wilsons would not be surprised to see upward dividend revisions across the market this reporting season, driven by improved earnings estimates along with a lift in dividend payouts.

The broker identifies energy, financials and materials sectors as all containing the potential for positive dividend surprise versus market estimates over the next three years.

Given that the dividend may be the tool of choice for companies to reinforce conviction and certainty around their recovery profile, Morgan Stanley forecasts for the ASX200 to ultimately return to a net yield of 4%.

However, the consensus is that companies will respond as economic risks continue to abate.

While the utilities, telco, energy and material sectors offer the highest projected yields, Morgans sees risks to energy and telcos as conditions continue to remain challenging.

Due to pricing and competition, the broker suspect firms may look to preserve capital until conditions improve. However, the opposite could be true when it comes to key major resource companies that are already comfortably de-geared.

With most of their surplus sale proceeds likely to make their way back into the hands of shareholders, Morgans expect above average dividends from the major miners.

Following APRA’s removal of dividend limits in December, Morgans also expects the major banks to be able to sustainably operate with much higher dividend payout ratios in the range of 65-75% over the forecast period.

In the case of Commonwealth Bank ((CBA)), Morgan Stanley notes its FY21 "excess" capital position of circa $6bn could be used to add $1bn-plus to the annual dividend for several years. [CBA has reprted this morning and exceeded dividend forecasts -Ed].

If viewed as sustainable in the medium-term, the broker thinks investors could be prepared to capitalise this higher dividend.

Beneficiaries of industry tailwinds

Morgans also expects healthy dividend forecasts for sectors that are benefitting from strong industry tailwinds, including retail and healthcare.

On the retail front, Morgans expects Harvey Norman ((HVN)), Super Retail ((SUL)), Nick Scali ((NCK)), and JB Hi-Fi ((JBH)) to reward income investors, with healthcare stocks like Sonic Healthcare ((SHL)), Virtus Health ((VRT)), and Monash IVF Group ((MVF)) to do the same.

With a current overweight cyclical positioning, Wilsons Australian Equities Focus List has expected dividend growth of 44% in FY21 and +16% in FY22.

This list is heavily influenced by companies like Aristocrat Leisure ((ALL)), James Hardie Industries ((JHX)), News Corp ((NWS)), Super Retail Group ((SUL)) and the banks, where dividends are very low – and/or were substantially cancelled due to covid-19 – and as consequence should bounce back quickly.

[James Hardie has since reported and provided an upside dividend surprise; News Corp last week cut its 2020 dividend in half but will reinstate in 2021 – Ed]

In addition to materials stocks like BHP Group ((BHP)), Northern Star Resources ((NST)), OZ Minerals ((OZL)) and James Hardie Industries which all contain potential for dividend surprise, Wilsons also thinks domestically-focused Seven Group Holdings ((SVW)) and Super Retail Group equally offer potential dividend upside this reporting season.

Iron ore miners remain the highest yield payers

Strong balance sheets give the diversified miners potential for December-half capital management.

While BHP and Rio Tinto ((RIO)) are both likely to channel surplus cash flow into strong cash dividends, Morgans expects the investor focus to remain firmly on Fortescue Metals’ ((FMG)) bumper cash dividends.

Fortescue's CEO recently reaffirmed the miner would likely keep its dividend payout at the top end of its 50-80% ratio.

For the December half, Morgan Stanley expects iron ore miners to have the highest dividend yields in its coverage, with Fortescue at 5.3%, followed closely by Rio Tinto at 4.6%, then BHP on 2.4%, and Mineral Resources ((MIN)) at 2.0%.

The highest annual CY20/FY21 dividend payers are also expected to be iron ore miners, including Fortescue at 11.8% and Mineral Resources on 7.4%; and copper miner Sandfire Resources ((SFR)) offering 6.7%.

Beyond iron ore and copper, Morgan Stanley looks to high yield commodity diversification in FY21/CY21 from Alumina Ltd ((AWC)) 4.7%, ST Barbara ((SBM)) 4.6%, or Regis Resources ((RRL)) 4.5%.

Likely to disappoint

In contrast to the prior reporting season, Morgans expects only a small proportion of stocks to cut dividends entirely, and suspects those that do could potentially include, a2 Milk Company ((A2M)), Emeco Holdings ((EHL)), Southern Cross Media ((SXL)), Uniti Group ((UWL)), and Vocus Group ((VOC)).

[Emeco has since reported, did not declare a dividend, and disappointed by not providing any definitive policy going forward – Ed]

The broker notes these cuts could be more likely due to company-specific issues rather than the broader covid-19 issues.

Having been hit by higher covid provisioning, it is also expected to be a more challenging dividend environment for the insurers.

While Morgan’s doesn’t expect QBE Insurance ((QBE)) or Insurance Australia Group ((IAG)) to pay a first half dividend given payout ratio targets, it thinks Perpetual Ltd ((PPT)) and ASX Ltd ((ASX)) have the potential to surprise with higher dividends at the half.

Dark horses

When looking for stocks with the potential for a surprise dividend, Morgan Stanley firstly looks at companies that have raised capital through the covid period yet have material declines in distribution profiles embedded in consensus expectations.

These include stocks such as Metcash Ltd ((MTS)), IDP Education ((IEL)), Cochlear ((COH)), Newcrest Mining ((NCM)), and Tabcorp Holdings ((TAH)), to name a few.

Then Morgan Stanley also looks at companies with declines forecast for FY21 dividends, but where FY22 earnings expectations are robust (above 10%).

These include Bingo Industries ((BIN)), Tassal Group ((TAS)), Computershare ((CPU)), Boral Ltd ((BLD)), and IOOF Holdings ((IFL)), to name a few. [Boral reported yesterday and did not declare a dividend – Ed]

While South32 ((S32)) has net cash of US$313m versus a target net debt of US$250m, and could extend its buyback (the broker estimates US$150m in FY22), Morgan Stanley suggests a payout could be delayed until the divestment of SAEC expected in March 21.

Other stocks to keep on radar for a potential dividend surprise, adds Morgans include Mitchell Services ((MSV)), Motorcycle Holdings ((MTO)), National Tyre and Wheel ((NTD)), and Virtus Health.

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