Tag Archives: Dividend Stocks

article 3 months old

SMSFundamentals: Yield Or Growth?

Which investment strategy has proven to provide the best risk/reward balance for the income-seeking investor over time? You may be surprised.

SMSFundamentals is an ongoing feature series dedicated to providing SMSF trustees with valuable news, investment ideas and services, in line with SMSF requirements and obligations.

For an introduction and story archive please visit FNArena's SMSFundamentals section on the website.

Yield or Growth?

By Greg Peel

The biggest challenge for retirees relying on their investments to provide income has, since the GFC, been a low interest rate environment stretching much further than was anticipated at the time. Investment in traditional safe income producers such as term deposits and government bonds simply do not offer a sufficient income stream.

This has forced investors into the stock market to a greater extent than they would otherwise feel comfortable with on a capital risk basis. Bank deposits and government bonds are considered “risk free” on a capital preservation basis. As the GFC proved, clearly equities are not.

The challenge for super investors is therefore to find the most comfortable balance between risk and income. To that end such investors will steer clear of growth stories that may be exciting but of little value, and of great risk, if that company does not pay dividends or pays only negligible dividends. The primary target must be dividend yield.

Yield stocks can be divided roughly into two categories: high yield and yield growth.

The first category contains those stocks paying a high dividend yield but offering minimal dividend growth. It includes stocks that for one reason or another have been beaten down, but as a result, yields on offer are very attractive. These are known as “value” plays.

The second category contains those stocks that pay a modest dividend yield but offer greater growth potential. These tend to be companies operating in industries that exhibit low cyclicality – they tend to plod along regardless whether the economy is performing well or not. They may not grow fast but they do grow, and they offer reliable cash flow to underpin dividend payments. These are known as “growth” plays.

It should be pointed out here than many an investor fails to appreciate that a quoted yield at any time, be it historical (looking back over twelve months) or forward (looking ahead over twelve months), is based entirely on today’s share price. The yield the investor actually receives is based on the share price paid on purchase.

Thus a stock showing a historical yield of 10% will not be paying 10% if the investor bought ahead of a large fall in share price. A stock showing a forward yield of 4% could be generating 7% for an investor who bought a year ago, ahead of a steady share price climb.

Which should the super investor target in order to provide the income required to fund lifestyle into the future?

That is the question asked by Rosenberg Equities’ deputy head of research, Michael G. Kollo PhD, in a paper entitled Hunting for Yield or Hunting for Growth?

To begin with, Kollo points out it is unfeasible to believe an investor can find one stock that fits into both categories – paying a sustainable high yield but also offering reliably solid growth. But we can consider that there is no clear border between the two. There is a grey area between the two extremes. Kollo’s research works on the basis of choosing between one style of portfolio over the other.

The research looks at the performance of two portfolios of equivalent capital investment, number of stocks and capital weighting over history, representing our two categories. The prime measure of performance is that of realised income – the yield the investor generates (based on starting price) multiplied by the amount of capital invested.

The point of realised income is that one can boast about what a portfolio is worth on paper today based on today’s share prices but for those reliant on income, that capital must remain the driver of income throughout the typical ebb and flow, and occasional boom and bust, of stock markets. Kollo makes the point that surprisingly, realised income is rarely discussed or reported by the wealth management industry.

The research considers four criteria: providing realised yield; capital risk; dividend payment risk; inflation risk and growth.

Which of the two portfolios provides the greatest realised yield?

We know that the answer is not immediately high yield because dividend yields are higher, because over time dividend growth can provide yields greater still. And at this stage we should point out the research is US-based, which is why the numbers look low compared to what we’ve become used to in the Australian market.

At the starting point of 4% dividend yield for high yield and 2% for growth, high yield delivered minus 2.2% dividend growth and growth delivered plus 6.7% dividend growth over time. Thus on a realised yield basis, high yield delivered 3.9% and growth 2.2%.

In other words, you’re better off going for high yield to begin with, because the market is paying up for growth potential and that’s why growth stocks offer lower yields.

Which of the two portfolios offers the least capital risk?

High yield stocks have a reputation for higher volatility. Companies with higher earnings growth, and so dividend growth, are assumed to be in better health and thus more able to withstand shocks than their lower growth, higher yield counterparts. But looking at the past twenty years, the research finds that on an investment horizon of three years or more there is little difference in capital deprecation over periods of downturn.

The conclusion is that over a longer investment horizon, higher yielding stocks do not increase capital risk meaningfully.

Of course in order for this to be the case, those high yields have to be sustained. Which brings us to the next question:

Which of the two portfolios offers the least dividend risk?

This is a good time to suggest investors ignore historical dividend yields and focus only on forward yields as forecast by stock analysts. A stock may look fabulous because it offers an historic 15% dividend yield but that yield is based on last year’s dividend divided by today’s share price, and that company may be at risk of going out of business.

Or at the very least, it will cut or suspend its dividends in order to weather whatever storm it is being battered by, macro or micro, meaning little or no yield for this year. Such stocks are known as “value traps”. But perhaps analysts are confident the company can address its issues and maintain dividend payments – herein lies the risk.

The research picks an obvious period of time – 2008-09 – to assess how many companies in either portfolio cut their dividends. One assumes the high yield portfolio would have been more prone.

And it was – 48% of high yield companies cut their dividends. But 45% of growth companies cut as well. And 30% of companies in both portfolios cut by 50% or more. Both types of companies, Kollo concludes, have shown an equal willingness to make major cuts to their dividends during periods of extreme stress.

Which of the two portfolios offers the greatest inflation risk?

Inflation risk is one of the greatest arguments for holding growth stocks given dividend growth is required to offset the impact of inflation on the investor’s purchasing power. High yield is all well and good until inflation erodes the purchasing power of income over time.

Over the longer term, equities have produced returns that have exceeded inflation in most decades, the research finds. In the instances they have lagged, equities have rebounded by an even greater extent in the subsequent period.

Between the two portfolios, we’d expect high yield to provide a surplus return over inflation initially but for that to gradually erode to a deficit. We’d expect growth is at risk of lagging inflation initially but would move into surplus over time. Indeed the research has found that the crossover – the point at which the returns of both portfolios equalise with respect to inflation – occurs at seventeen years.

In the two most extreme scenarios of stagflation (falling economic growth, rising inflation) and stagnation (falling economic growth, falling inflation), the growth portfolio provides a zero or negative real return for a significant portion of the investment period. High yield provides a significant excess return before gradually eroding over time.

If we assume that a super investor would feel more comfortable with the bird in the hand in such circumstances – excess income in tough economic conditions -- then the high yield portfolio is preferred.

The Conclusion

“We find that the High Yield strategy delivered consistently higher income,” Kollo concludes, “by virtue of its higher delivered yield, than the Growth strategy over the short to medium term. Some simple analysis suggests that under adverse economic scenarios, the High Yield strategy provides greater utility for investors due to excess cash flows in the early years.

“Capital risk is approximately equivalent for the two strategies, while cash-flow risk in terms of cuts to dividends during a crisis is also near-identical. In sum, our analysis suggests that a higher yield, lower dividend growth strategy provides a superior delivered income experience with equivalent risk for investors.

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article 3 months old

Dividends: More Is Less, Less Is More

In this week's Weekly Insights:

- Dividends: More Is Less, Less Is More
- Australia Joining Global Low Inflation?
- All-Weather Price Tracker
- Industry Structures Revisited
- #NigelNoMates Not Enjoying A Holiday
- Catching Up On The Past
- Rudi On Tour
- Nothing Ever Changes, Or Does It?
- Rudi On TV

Dividends: More Is Less, Less Is More

By Rudi Filapek-Vandyck, Editor FNArena

"We are in a desperate period. Policymakers have taken it upon themselves to convince the world that they know better than the markets where interest rates should be, and are following a path that all but guarantees the very secular stagnation they are trying to avert - and that will lead eventually to a massive financial crisis."
[Charles Gave]

Over the past five years, the MSCI AC World index, representing equities for the global investor, has delivered a return of just 3.8% per annum, ex-dividends.

In Australia, share market returns over the past two years have been worse. Luckily, the Australian share market offers partial compensation by offering the world's highest yield from equities, on average.

No wonder investor attention is so much focused on dividends and on yield these days. It's what is required in order to achieve reasonable & acceptable returns, or so it appears.

Dividends: The Trend Has Been Your Friend

In the example of the MSCI AC World index, the average dividend yield over the past five years has been 2.9%, implying a direct contribution to total returns of more than 40% over the period. In Australia, the average dividend yield is usually around 4.5% but recent cuts, predominantly by resources companies, have lowered average yield for the ASX200 to circa 4%.

For superannuants in retirement phase trying to live off annual income from their investments, 4% probably is not enough, so they have gone searching for higher yielding alternatives. 6%. 7%. 8%. To those hunting for higher yield, it's all available in the Australian share market. Their key consideration is: can companies continue to pay at least the same dividends in years to come?

Despite high profile dividend cuts by the likes of BHP Billiton ((BHP)) and Woodside Petroleum ((WPL)) earlier this year, the answer in the overwhelming number of cases has been: yes, the company can.

Thus far, dividend-oriented investors have had the trend on their side. Faced with tougher growth and lower returns, companies have increasingly succumbed to satisfying growing investor demand for income/yield by jumping on the bandwagon themselves and sticking to the script at all costs.

Australia has a long tradition in this field, but consider, for example, in 1998 only 35% of companies in ASEAN countries paid out dividends to shareholders. Today the percentage is a whopping 95%. The average payout ratio throughout the region has steadily lifted over the period to 50% today.

But this is not an opportune moment to become complacent. There's a fair argument to be made the first cracks in the global dividend theme have now started to appear. With growth tepid and payout ratios often at elevated level, investor attention should now more than ever be focused on "sustainability" and on "growth".

While the absence of the latter might seem less important to income-only seeking investors, absence of growth can translate into capital losses in the short to medium term, and impact on sustainability in the longer term.

Why Less Is (Often) More

Share markets are not always efficient, they are not even always right, but they do have a sixth sense for separating the strong from the weak, in particular when it comes to dividend paying companies. Remember when BHP Billiton was supposedly offering double digit yield? Well, a few months later, and now the board has succumbed to the inevitable, BHP shares are trading on (forward looking) a yield of circa 3% (ex-franking).

In more subtle fashion, the share market provides investors with similar insights on a daily basis. Consider the graph below, taken from my eBook "Change. Investing in a Low Growth World", published in December last year.

The overview is based upon close monitoring of the yield trend that has dominated global equities over the five years past. It suggests that when it comes to deriving yield/income from the share market, "more" is seldom best while "less" might generate a lot more (in total return).

The practical application of this market observation is probably best illustrated through my list of personal yield favourites in the Australian share market: APA Group ((APA)), Goodman Group ((GMG)), Sydney Airport ((SYD)) and Transurban ((TCL)). All offer yields between 3.5%-4.5%. All remain in positive territory thus far in 2016, dividends not included, and all have generated positive returns in 2015 as well as in the years prior.

In contrast, ANZ Bank ((ANZ)), whose implied forward looking yield has now risen above 7% (franking not included), has not managed to add any capital gains on top of the annual payout in dividends both in 2014 and 2015. With the share price down significantly already since January, 2016 might well become the third year in succession that total shareholder return will be less than the yield on offer.

The principle also applies among the banks with both CommBank ((CBA)) and Westpac ((WBC)) offering lower yield but significantly outperforming their higher yielding peers ANZ Bank and National Australia Bank ((NAB)).

Of course, the share market does not always get it right, but as a standard guide I think the samples above speak for themselves.

A Smorgasbord Of Possibilities

Investing in yield stocks is not a static concept. Changes in the economic cycle lead to shifts in investor preferences, impacting on share price momentum and, ultimately, on total investment return.

Often market commentators and investors take guidance from overseas leads but, beyond the day-to-day volatility, regional differences command differences in yield preferences and thus tailored investment strategies.

First, let's take a brief look at the various options of yield stocks & strategies investors can choose from:

- Bond proxies; defensive stocks with plenty of cash flows (hence the potential to offer yield) but oft with low to no growth. Think REITs and infrastructure owners & operators.

- Growth at a Reasonable Yield, also known as GARY; reasonable yield, backed by growth which is not yet priced at too high a Price-Earnings (PE) multiple. GARY often leads investors to industrial companies trading on mid-to low teens PEs while offering 4-5% yield. In today's context this could include the likes of Pact Group ((PGH)), Lend Lease ((LLC)) and Smartgroup ((SIQ)).

- Dividend Champions; companies who have a long history of not cutting dividends. In Australia Telstra ((TLS)) would be such an example and arguably the major banks. The obvious warning here is the legacy from the past doesn't count for much when things turn really dire. In years past companies including BHP Billiton, Metcash ((MTS)), Fleetwood ((FWD)), GUD Holdings ((GUD)), et cetera that used to have an enviable track record, have been forced to reduce or to scrap dividends.

- Cash proxies; companies swimming in cash but with low "beta". Genworth Mortgage Insurance Australia ((GMA)) just announced a special distribution of 34c per share plus consolidation of its outstanding capital.

- Yield at Low Risk; see my graph above and my favourite yield stocks.

- High Dividend Yield; Nine Entertainment ((NEC)) currently offers 8.6% (no franking), Monadelphous ((MND)) is not far behind and DUET group ((DUE)) is offering 8.14%. Investors should be aware at all times share markets do not offer free lunches, but sometimes all that matters is the potential yield on offer.

- Low Yield with Strong Growth; Investors who bought Blackmores ((BKL)) shares three years ago are this year enjoying a forward yield of 6.74% on their original purchase, plus franking.

Dividends: Cycle & Regional Differences

Analysts at CLSA recently issued a stern warning: average free cash flow (FCF) cover among US listed companies has in the past three years sunk to below 1. One possible explanation is that companies have been using low-cost borrowing to fund payouts. As financial conditions tighten amid slower growth, CLSA believes payouts will become unsustainable, with buybacks likely to take the biggest hit, but dividends should come under extra scrutiny too.

But the biggest risks to dividends are among companies in Emerging Markets, with Latin-America and Asia topping the list of CLSA's global concerns.

In Australia, the analysts anticipate a continuation of the low growth environment and thus their preference is for GARY and Dividend Champions when it comes to yield-oriented strategies. In terms of the Australian banks, CLSA is of the view banks should be put in the basket of "bond proxies", which provides an insight into their preferred stock inclusions.

For Developed Markets in general (see chart below) CLSA advises GARY and Yield at Low Risk are likely to generate the best results. This aligns with my own view and analysis for Australia too.

Australia Joining Global Low Inflation?

Traditionally, Australia's consumer price inflation has always been markedly higher than in the larger, developed economies.

Being smaller and mainly surrounded by water is but part of the explanation. Having plenty of industries run by cosy oligopolies has certainly played a key part in this story too.

Now that technology is breaking down barriers and distance, and international competitors and new market entrants are changing the Australian economic landscape, should we expect a transformation in the local inflation outlook too?

Economists at UBS certainly are engaging the idea and they released a rather bold research report into this matter on Monday, predicting Australia might be joining the global low inflation movement from here onwards. This prediction is going to attract widespread attention without doubt. If not domestic media, then certainly the economist community will direct their attention to the deciphering of Australia's CPI dynamics by Scott Haslem and his team.

Bottom line: if inflation is now structurally heading towards lower levels, as arguably has already happened in the USA, Europe, et cetera, then this will have ramifications for RBA policies and the so-called Neutral cash rate, which should shift lower too, all else being equal.

Reports UBS: "Recent quarters have delivered the lowest core inflation prints (on average) in 18 years".

And to really bring home the point: "We see an 80% probability that inflation will print below the RBA's end-2016 2½% y/y forecast mid-point". Let the national inflation debate begin!

Given the heavy yield weighting in the Australian share market, the current trend in underlying inflation should thus be supportive for equities in general, point out UBS economists. Exporters will benefit from a weaker Aussie dollar.

As per always, there will be losers too: "lower inflation would bring negative profit implications in some sectors, such as consumer staples, general insurers, domestic health care and telcos".

All-Weather Price Tracker

Every quality newsletter deserves a subscriber such as James B. Having followed my analysis into changing market dynamics and All-Weather Performers from the sidelines for a while, James finally bit the bullet earlier this year and decided to join FNArena as a paying subscriber.

Since then he has written a number of emails, including directed at Nigel NoMates, said Hello when meeting me in Manly, and spent a few weekends and afternoons on calculating and re-calculating the numbers available on All-Weather Performers. His end conclusion: there is a whole lot to say in favour of these All-Weather Performers. Their performance in years past has been much better than the broader market, no matter how we slice and dice the numbers.

Thanks James. Good to see that my own research/analysis/calculations withstood the extra scrutiny of a motivated investor as yourself who really wanted to get to the bottom of this. Needless to say, James B has now been converted to the theme.

James's last email (thus far) reached us over the Easter weekend. Whether all stocks mentioned in the monthly price tracker (in excel - for paying subs only) should still be regarded All-Weather Performers looking forward, or was there some legacy from the past as well?

Timely question. I had already concluded our monthly update needed a general revamp, including for the structural growth sectors I had identified in last year's eBook "Change. Investing in a Low Growth World". From this month onwards there should be no more such questions, from James or from anyone else, as we have conducted a general review and restructured the price tracker.

Paying subscribers can send a request to info@fnarena.com

Industry Structures Revisited

My previous Weekly Insights, Bear Market Diaries - Episode 6 (March 21, see below), mentioned research by Credit Suisse into industry structures and how they impacted on sustainable, lasting shareholder wealth creation by companies operating under such supportive dynamics. No guessing as to why I suggested investors should include such research when conducting their own.

Alas, Credit Suisse has since been forced into releasing a correction on the research. Someone had used one of the tables with calculations upside down. We're all human, of course, but there's very few worst alternatives to having published a major piece of research and then having to release a correction which substantially changes the framework. I feel sorry for the lads at Credit Suisse.

Turns out, investing in companies with very bad industry dynamics over time generates similar results as investing in supportive industries. The ones missing out, if we rely on this angle only, are companies operating under rather neutral sector dynamics.

That's the statistical end conclusion. Credit Suisse points out while this might be true, the approach to investing in the two opposites would certainly have to be different. When it comes to weak industry structures, the search should probably focus on beaten down stocks who either attract the attention from a corporate suitor or whose fortune is about to turn for the better.

When looking for strong, supportive industry dynamics, investors can take note of the fact this has been one of key factors in support of my own research into All-Weather Performers. These stocks trade on market-premium valuations, and for good reasons too. I sincerely hope all readers of my weekly updates have a good portion of those in their long term investment portfolios.

Regardless, the revised outcome of Credit Suisse's research is intriguing, to say the least, and once again shows there is no such thing as one strategy or one approach that fits all circumstances and suits all kinds of investors.

#NigelNoMates Not Enjoying A Holiday

Nigel remains sceptical whether central bank actions in March have now fundamentally re-shaped the outlook for the global economy and for financial assets.

Catching Up On The Past

In case you missed some of the preceding stories, here's your chance to catch up (in reverse order):

- Rudi's View: 2016 is The Year Of Conviction

- Rudi's View: Who's Afraid Of The Big Bad Bear?

- The Bear Market Diaries - Episode 1

- The Bear Market Diaries - Episode 2

- The Bear Market Diaries - Episode 3

- The Bear Market Diaries - Episode 4

- The Bear Market Diaries - Episode 5

- The Bear Market Diaries - Episode 6

Rudi On Tour - Who's Afraid Of The Big Bad Bear?

They seem to come along every eight years or so, the dreadful bear market so many investors detest, causing risk appetite to evaporate and share prices to reset at lower levels. Every time the cause and follow-through are different. So what lies at its origin this time and what's going to be the likely outcome? As a self-nominated bear market expert, I will be sharing causes, explanations, insights and strategies for investors who want more than keeping their fingers crossed while hoping for the best.

I will be presenting:

- To Perth chapters of both Australian Shareholders' Association (ASA) and Australian Investors' Association (AIA) for presentations on Monday 9th May, both afternoon and in the evening.

- To Melbourne chapter of the Australian Shareholders' Association (ASA) in early July

- At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.

- To Chatswood chapter of Australian Investors' Association (AIA) on September 7, 7pm, Chatswood RSL

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).

Here's the link to Amazon: http://www.amazon.com/Change-Investing-Low-Growth-World-ebook/dp/B0196NL3KW/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1454908593&sr=1-1&keywords=change.investing+in+a+low+growth+world

See also further below.

Rudi On TV

- On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
- I will be appearing as guest on Sky Business's Trading Day, 12.30-2.30pm on Thursday
- Still on Thursday, I shall appear on Switzer TV, between 7-8pm
- On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 4 April 2016. 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).



Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:

- The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
- Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
- Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
- Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup 

article 3 months old

Yield Stocks Continue To Find Favour

-A-REITS offer most certainty
-Yet limited value opportunities
-Internal growth opportunity in utilities
-DB prefers SYD in infrastructure


By Eva Brocklehurst

The environment for yield stocks remains favourable, particularly Australian Real Estate Investment Trusts (A-REITs), which brokers consider offer another strong year of returns in the midst of stable bond yields.

Volatile global markets should ensure the A-REITs remain at the forefront, in JP Morgan's view. The broker does acknowledge total returns will be more modest in 2016, around 5-10% after three years of strong performance, amid expectations the asset cycle has peaked.

JP Morgan retains a preference for Westfield Corp ((WFD)), Stockland ((SGP)), Mirvac Group (MGR)) and Lend Lease ((LLC)). The broker is underweight on small cap A-REITs.

Macquarie compares several sectors that offer the best yields and finds, in terms of the initial yield versus a total return, utilities actually offer the highest at 6.9%. A-REITs are in second place with 5.7% and infrastructure in third with 5.3%.

When it comes down to certainty, the A-REITs offer the most, although Macquarie accepts there have been few negative surprises from the other two over the last few years. Infrastructure stocks offer the highest total return to shareholders over the medium term but this is matched by a higher level of leverage.

All these sectors are capital intensive and Macquarie finds limited earnings or value accretive opportunities are presenting for A-REITs. In contrast, the utility sector has internal growth opportunities via capacity additions that are underpinned by long-dated contracts.

Among its key ideas for the three sectors Macquarie singles out GPT ((GPT)) in A-REITs, given its attractive earnings and cash-flow growth profile. Preference also lies with stocks that have tangible earnings/asset value drivers such as Westfield, Goodman Group ((GMG)) and Lend Lease.

Preferred stocks across road and airports are Macquarie Atlas ((MQA)), Transurban ((TCL)) and Sydney Airport ((SYD)) as these all provide dividend growth of over 10%. Issues surrounding regulatory re-sets and technology disruption limits any re-rating for utilities, in Macquarie's view.

Deutsche Bank has never had an issue with the quality of the infrastructure sector, just the valuation. The broker reviews the cost-of-equity discount rate applied to stocks under coverage and observes a trend for values to increase via reduced risks, as assets mature, as well as through the compression of the discount rate that is applied.

The issue for the broker is how much to pay for these high quality assets during volatile times. The required rates of return have continued to fall over time as the understanding of the assets has increased and, hence, the risk is reduced as well.

Deutsche Bank believes the downward trend in returns is likely to continue into the foreseeable future, because of the low interest rate environment that prevails. Still, the broker remains cautious applying a lower long-term discount rate, given the long-dated nature of the assets exposes them to interest rate risks and technology changes.

Rates are likely to remain at similar levels for the foreseeable future and Deutsche Bank chooses an 8.0% discount rate out to 2020, reverting to 9.0% for the long term. This effects an increase to the price targets for Sydney Airport, to $6.65, Macquarie Atlas, to $4.45, and Transurban, to $10.20. Deutsche Bank prefers Sydney Airport of the three, expecting increased benefit from growth in international capacity and other commercial developments.

UBS anticipates another strong year for the real estate sector, with 5.0% distribution yields, 4.0% growth and a discount to fair value that leads to a 10% total return forecast for 2016. The broker envisages a risk to pricing when 10-year bond yields being to rise but so far 2016 appears benign.

The broker observes key investment themes include a re-rating of the residential developers as the cycle moderates, defensives delivering on core returns and confidence improving for previously unloved names. In the latter case, UBS has upgraded Vicinity Centres ((VCX)) to Buy. The broker prefers Westfield over Goodman for international exposure.

Morgan Stanley retains a preference among A-REITs for those with clear disposal and development strategies. Office names are expected to report the strongest increases in net tangible assets while supermarket-anchored landlords are expected to make smaller gains.

The broker expects demand for Australian commercial property will be maintained. This underscores a preference for those names which sell non-core assets into strength and redeploy proceeds to improve portfolios via re-development.

Morgan Stanley avoids those stocks which are maintaining strategies to make acquisitions for near-term earnings accretion such as Charter Hall Retail ((CQR)) and Charter Hall ((CHC)). Morgan Stanley's top picks in the sector are Goodman Group, Lend Lease, Westfield and Vicinity Centres.

The decision by Woolworths ((WOW)) to exit its Masters hardware chain has implications for retail A-REITs, Macquarie asserts. Those with the most exposure to Masters include Aventus Retail Property ((AVN)), Charter Hall and Shopping Centres Australasia ((SCP)), although the broker concedes this is not significant at a group level.

The broker suspects the A-REITs are well placed to recoup unpaid rent, with the average term remaining on the leases typically 12-20 years. If the site is located in a metro location the A-REITs are expected to agree a deal early if they can secure and alternative tenant.

The Masters rent per square metre is typically quite low compared with other retail uses yet a lot of space will have to be re-leased and the capex cost for re-fit could be elevated if the intention is to divide into smaller tenancies. The broker expects, if the entire Masters network is closed, this would be a positive for Bunnings' anchored real estate, BWP Trust ((BWP)).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Superior Strategy Also Offers Best Protection

In this week's Weekly Insights:

- Superior Strategy Also Offers Best Protection
- Lies, Silliness And Stats
- Update On All-Weather Performers
- Share Buybacks - Who's Doing It?
- Rudi On TV
- Rudi On Tour

Superior Strategy Also Offers Best Protection

By Rudi Filapek-Vandyck, Editor FNArena

It happens every time and last week in front of an audience of ATAA members was no different.

From the moment I show one of my favourite slides, illustrating the outcome of in-depth data analysis by analysts at Goldman Sachs for the years 2000-2014 (see below), supporting my own research that combining dividends with growth is the superior investment strategy in the long run, all of a sudden time stands still, for a while.

Pupils dilute, brows frown, backs straighten up, breathing in the room goes to slo-mo. If I pay close attention I can almost hear dozens of human hard drives accelerating into superfast overdrive status.

For what the eyes are seeing, and what I am pointing out verbally on stage, is so outrageously in contradiction to what everybody "knows" about the share market it almost equals blasphemy.

Yet, there it is, in three neatly construed performance calculations for the ASX200, high yield stocks and dividend + growth stocks; the latter strategy has outperformed the index by close to 100% and high yield stocks by a factor 2.5.

What about the absence of a separate bar for growth stocks only? There's always one who doubts and questions the absence of one dedicated fourth performance bar that would have simply added more visual evidence to the same conclusion: dividend + growth beats everything else, just not necessarily on a day-by day, short-term basis.

Sustainability Is The Key

Let's for now not get bogged down in the nitty gritty details of the above chart or Goldman Sachs' research. This is not the first time I have written about this and I literally do talk about it every time I get up on a stage. It is not that difficult to figure out why growth-only stocks have not delivered superior returns: the keyword here is "sustainability".

Let's take Incitec Pivot as an example. In the halcyon days before the 2008 meltdown, the share price rallied from $1 to $8, but then fell back to $2. By 2011 it had clawed its way back above $4 but retreated back below $3 and the rally in recent times had taken the share price back above $4, but it has again retreated since.

The story whether Incitec Pivot shares have been a good or bad investment quickly harks back to two simple questions:

-when did you get in?
-when did you get out?

Assuming investors' timing to get in was not perfect (i.e. at the lowest price point possible), returns have been very much dependent on when exactly one decides is the cut-off to measure it. Let's be honest: it probably wasn't such a good idea to buy the shares for a typical set-and-forget strategy. Unless your timing/entry-price was perfect (Hindsight can help with such observations, but foresight much less so).

Luckily, for investors, Incitec Pivot pays out a dividend twice per year. This is one of the key factors to remember about 2000-2014; when share price gains melt away, the dividends in your pocket do not disappear in sympathy. They are non-refundable. Admittedly, you will be eligible for tax -one important factor never included in such research- but fact remains: what you receive in dividends is all yours. The gains you have in share price appreciation are only yours until the next sell-off, pull-back, correction or otherwise downward movement, unless you sell or take profits on time.

We all know, from harsh first hand experience or otherwise, that I could've easily replaced Incitec Pivot with BHP Billiton, Woodside Petroleum, JB Hi-Fi, Woolworths and many, many others. One way to read the graphic above is by acknowledging that sustainability hasn't been great for the large majority of so-called growth stocks.

Yield Is Not Defensive

The second observation that stands out is high yielding stocks are one sure way to underperformance. This may surprise many, as high yielders have done exceptionally well from mid-2012 onwards until earlier this year, and most investors would put the major banks under "high yield".

Fact is, Australian banks have been such a wonderful and rewarding investment since the mid-1990s because they offered yield + growth. As such, they have contributed to the ASX200 and to the yield + growth performance bar, not to the underperforming high yield basket of stocks.

What Goldman Sachs' analysis confirms (and every investor should know this) is that investing in the share market is always somewhere, somehow linked to growth. Despite all the fads and bubbles throughout times, at the end of the day no investment strategy can be successful or rewarding in the long run unless it has been backed up by growth.

The "secret" as to why high yield stocks deliver a far less satisfying return in the long run is visible through the dark blue parts of each performance bar. These are the returns from share price appreciation only. The share market has a tendency to de-rate stocks that go ex-growth. If they pay dividends, there's a natural support at an above market average yield. But if there's no growth, there won't be much in terms of share price appreciation, if one's lucky, otherwise the share price might actually fall.

In terms of total return, the dividends on offer in many cases represent the maximum return available, and this is not taking into account the risk that dividends might actually have to be cut or suspended or scrapped altogether.

The best way to make a comparison with stocks that offer dividend + growth is by acknowledging those dividends are the minimum return on offer, with share price appreciation on top. Maximum versus minimum. Have a good think about this. It may solve many dilemmas that are currently on investors' minds.

Whatever your angle/horizon/strategy, never make the mistake to treat investing in dividends as a defensive move. One of the first sentences in the Goldman Sachs report stated dividends were not a defensive tool. I cannot highlight this point prominently and often enough. If you choose the right stocks, those that combine sustainable dividends (cash flow) with sustainable growth, you will find there's less downside in turbulent times (because of dividend support) and more total return over time, which is a superior strategy. Nothing defensive about any of this.

One Often Ignored Important Factor

One factor that has co-determined the large differences in total returns between various strategies throughout the fourteen years as analysed by Goldman Sachs is the top part of each performance bar; re-investment. You receive dividends from the companies in your portfolio. What do you do with them?

According to the Goldman Sachs research, you better reinvest them in those stocks that offer dividends + growth. The return from such reinvestments has dwarfed total return from high yield stocks and pretty much equaled total return from the ASX200 without franking and reinvestment. But then reinvesting in growth stocks has not been equally rewarding. Again, it all comes down to sustainability. Putting your dividends in a stock that is going to have a bad year next is simply adding more to a stock that is going to cause losses.

Reinvesting in companies that offer dividends + growth will, at the very least, increase next year's dividends. In practice, the better industrial stocks pay out dividends to shareholders while still investing for growth and generating plenty of cash and growth from their core operations. It goes without saying my selection of All-Weather Performers (see below) has genuinely distanced itself from the majority of ASX-listed alternatives through consistency and sustainability. Two key values that determined the outcome of the Goldman Sachs research.

And of all investment strategies over the period.

This Time Is Different, Or Not?

It is oft heard: the yield trade is over! However, if we genuinely pay attention to what the Goldman Sachs research implicates, then the yield trade is never ever really over. What has been happening is the share market went a little overboard with an extreme focus on yield and on yield only, because that just happened to be the theme of the moment, and there was plenty of money to be made from it for quite a while.

Those days have gone and what we are seeing now is a "normalisation" of sorts. Extreme yield valuations have deflated, not the least in the form of a decent sell-off in bank shares. Is the RBA going to cut again? Believe me, nobody really knows, not even those economists making declarations full of confidence. But bond yields have been rising across the developed world and they might have further to go.

The best protection against rising bond yields is, you guessed it, combining dividends + growth.

Stocks that only offer dividend ("yield") trade in direct correlation with bonds, so there's little protection if bond yields do rise further. Add growth and you might see short term weakness, but eventually the share price is more likely to come out on top.

Investors should note that Big Banks in Australia (three of the Big Four, NAB is the exception) have been such a rewarding and sustainable investment because they combined dividends with growth. Right now, the dividends still look pretty solid, but the growth part has a big question mark attached. Same applies to Coca-Cola Amatil and to Woolworths.

Meet GARY, He's Your Friend

Rising bond yields in Europe has genuinely put the kybosh on global consensus trades. Ever since the calendar started approaching May global financial markets have become a lot less predictable and a lot more volatile. In Australia the share market has lost a lot of its prior glamour, not in the least because resources stocks have given market watchers whiplash, while insurers and the banks have settled at lower price levels. It's been a hard slog for the long-time faithful.

Analysis by analysts at Morgan Stanley suggests the best performers throughout this turmoil have been stocks characterised by the acronym GARY, which stands for "Growth and Reasonable Yield". Again, see also Goldman Sachs research and my own five cents worth above.

Morgan Stanley's favourites to play this theme include Macquarie Group ((MQG)), Tabcorp Holdings ((TAH)), AMP Ltd ((AMP)), Super Retail ((SUL)) and JB Hi-Fi ((JBH)). The stockbroker also still likes USD-earners with ongoing favourites Macquarie, James Hardie ((JHX)), Goodman Group ((GMG), Ansell ((ANN)) and ResMed ((RMD)).

Deutsche Bank Agrees

Market strategists at Deutsche Bank agree the best defense against rising bond yields is probably a combination of yield plus growth. Their model portfolio has several stocks that fall under this label, including Stockland ((SGP)), Fletcher Building ((FBU)), James Hardie and Harvey Norman ((HVN)) with exposure to building, Perpetual ((PPT)), AMP and Iress ((IRE)) with exposure to financial markets and QBE Insurance ((QBE)) and Sonic Healthcare ((SHL)) as so-called defensive growth stocks.

So many angles, so many ways to play the dividend theme.

More Dividend Ideas

I recently appeared a few times on Switzer TV to discuss and share my thoughts on dividend stocks. This has forced me to pause and take inventory.

In the basket of traditional yield stocks, my personal Top Five consists of (in no particular order): Telstra ((TLS)), Goodman Group, Transurban ((TCL)), APA Group ((APA)) and Sydney Airport ((SYD)).

Among industrials offering yield + growth all of the following stocks come with specific risks and twists, so investors are advised to get acquainted with them through further research (in no particular order): Asaleo Care ((AHY)), Flexigroup ((FXL)), Nine Entertainment ((NEC)), Energy Developments ((ENE)), Sigma Pharmaceuticals ((SIP)), GUD Holdings ((GUD)), Pact Group ((PGH)) and Navitas ((NVT)).

Subscribers should be aware they can do their own research into dividend + growth stocks via Sentiment Indicator and Stock Analysis on the FNArena website. In addition, the FNArena-Pulse Markets All-Weather Model Portfolio does include dividend stocks, including a few from the above mentioned.

P.S. The best performing stock in the Model Portfolio to date is Macquarie Group.

The Big Threat Ahead

The Big Threat ahead for Australian investors may not necessarily be related to rising bond yields but instead to the unsustainability of high payout ratios, warns Credit Suisse quant analyst Richard Hitchens. Again, I believe if investors focus on dividend + growth they are less likely to be hit by the unpleasant surprise of a lower payout ratio and what this possibly can do to the share price in the years ahead.

The adage "yield is not a defensive strategy" will no doubt come to the fore again from the moment companies start announcing lower payout ratios, effectively meaning yields will drop, but this may not happen in 2015 just yet.

Lies, Silliness And Stats

Let's start with a confession. I never sit with baited breath behind my pc screen waiting for a data release in order to buy or sell a financial asset. Then again, I don't think this will come as a surprise to anyone who has been reading my commentary and analysis over the past decade or so. But excuse me for sometimes feeling a bit "alien" when I observe how one small piece of data release -so tiny in the bigger scheme of things- has algorithms, machines, traders and market experts alike all fired up.

This is even more so the case when one actually realises how fickle the outcome for these data releases often is. See, for example, the worldwide research explosion into how "seasonal adjusted" in the US effectively amounts to "underappreciated". For those who haven't genuinely followed the discussion: the USA has now built up a legacy of starting off on underwhelming GDP growth in Q1 (pretty much each calendar year) and economists are blaming the statistical amendments that are being made to data collected.

The latest CPI read in the USA equally had tongues wagging (and trigger happy fingers acting) on Friday. Here's the opening sentence from the Monday morning response from the economy desk at National Australia Bank:

"If US April core CPI had printed just .007% lower than the 0.256% it actually did, it would have been rounded down to 0.2% on the month not up to 0.3%, and arguably most of Friday's market price action wouldn't have occurred".

Please forgive me if, at times, I do feel a bit removed from it all. Not my game.

Update On All-Weather Performers

First up: since late last year FNArena, in conjunction with partner Pulsemarkets, has been running an All-Weather Model Portfolio based upon my personal research post 2008. The direct aim is not to beat the index or the bulk of funds managers out there, but to offer investors a genuine alternative through diversifying away from the usual suspects in the Australian share market, to offer a less risky & less volatile portfolio but with ongoing positive rewards. And to prove in real-time share market exposure that my research has a lot going for it.

Within this framework I can report that, unless things change dramatically in the coming days, the All-Weather Model Portfolio seems poised to beat the major indices over the first five months of the calendar year. And we still have a big chunk sitting in cash on the sidelines, for whenever we think time or valuations are right to allocate more.

This is not me trying to claim a prize this early in the process. There is no such prize as this is a long term endeavour. Time to consider/re-consider a few things: your portfolio does not need to be overweight major banks and/or major resources simply because that's how the ASX200 is weighted. The All-Weather Model Portfolio has zero exposure to these stocks.

Also, don't fall for the dominant idea that stocks should always be bought cheaply and only cheaply for the long term. If you do your research well, you'll notice certain stocks seem always "expensive", but they perform well. The All-Weather Model Portfolio contains stocks that haven't looked "cheap" in ages, but they are in the portfolio and responsible for its (out)performance to date.

In response to recent queries about when I intend to publish the next update on this category of stocks: I'll try to do it before the August reporting season. Promise. But bottom line: not much has changed since the last update in December. Those who are interested in finding out more about said Model Portfolio: send an email to info@fnarena.com

Share Buybacks - Who's Doing It?

Below is an incomplete overview of companies buying in their own shares this year. We very much appreciate all contributions and suggestions at info@fnarena.com

- Amcor ((AMC))
- Aurora Buy-Write Property Income Trust ((AUP))
- Australian Governance Masters Index Fund ((AQF))
- Boral ((BLD))
- Centuria Capital ((CNI))
- CSL ((CSL))
- DWS Ltd ((DWS))
- Fairfax Media ((FXJ))
- Fiducian ((FID))
- Finbar Group ((FRI))
- GDI Property Group ((GDI))
- GWA Group ((GWA))
- Industria REIT ((IDR))
- Lemur Resources ((LMR))
- Logicamms ((LCM))
- Matrix Composites & Engineering ((MCE))
- Nine Entertainment ((NEC))
- Orica ((ORI))
- Pro Medicus ((PME))
- ResMed ((RMD))
- Rio Tinto ((RIO))
- Seven Group ((SVW))
- Sigma Pharmaceuticals ((SIP))

Wants to buy in own stock (but still awaiting shareholders approval): Intrepid Mines ((IAU))

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:

- May 29, CEOs lunch French Chamber of Commerce
- August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland - for more information about this event:


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

(This story was written on Monday, 25 May 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).



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.



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 April available (Next week we'll have an update for May). Just send an email to the address above if you are interested.

article 3 months old

Your Editor On Switzer: Healthcare, Contractors And Yield Stocks

Healthcare, Contractors And Yield Stocks

FNArena Editor Rudi Filapek-Vandyck discussed recent market movements with TV host Peter Switzer with a focus on healthcare stocks, All-Weather performers, mining services providers and yield stocks.

To view the broadcast, click HERE

Past broadcasts can be viewed via the Investor Education section on the FNArena website: https://www.fnarena.com/index2.cfm?type=dsp_front_videos

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article 3 months old

Your Editor On Switzer: Long Live Dividend Stocks!

Host Peter Switzer and FNArena Editor Rudi Filapek-Vandyck discussed long term virtues and dangers of investing in solid dividend paying stocks.

To view the broadcast, click HERE

Past broadcasts can be viewed via the Investor Education section on the FNArena website: https://www.fnarena.com/index2.cfm?type=dsp_front_videos

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article 3 months old

Is That It For Woodside’s Dividends?

- Filling the growth gap
- Not a fire sale price
- Can Woodside add value?
- Payout ratio safe for now

By Greg Peel

Oil & gas companies, like miners, are not typically “yield” stocks. Wells and mines only offer finite resources, thus resources companies must continually invest earnings into future growth opportunities, which usually means only a minimal payout of cash flows to shareholders. But as the China-driven resources boom of the twenty-first century has shifted from the growth stage to the production stage, and commodity prices have fallen back towards longer term averages, Australia’s resources companies have decided to back off on their ongoing growth spending and increase their dividend payouts to shareholders.

In the mining space, the two big diversified miners have done it, or at least are in the process of doing it. Australia’s oil & gas companies with LNG interests in PNG and/or Queensland are still spending on development, but are about to lift their dividend payouts once revenues flow. Woodside Petroleum ((WPL)) in the meantime had already lifted its dividend payouts, substantially, given a lack of viable growth opportunities to invest in.

While Woodside’s Pluto LNG facility began producing in 2012 and providing solid cash flows, the hope had always been to build a second and maybe third train, but the gas just wasn’t there. The company’s Sunrise asset in East Timor waters has pretty much gone into the too hard basket and its attempts to invest in the Leviathan project in Israel were abandoned after frustrating indecision from the Israeli government. That left the Browse project as about Woodside’s only option, but an onshore LNG facility would have attracted all sorts of problems and costs.

Woodside stuck with Browse, but pushed out its timeframe on the intention to build a floating LNG facility. Management then began a worldwide search for suitable projects in which the company could invest for future growth purposes, but nothing was ever going to jump out immediately, and all the good ones were gone. In the meantime, cash was rolling in by the barrow-load from both Pluto and Woodside’s stake in the legacy North West Shelf operation. There was little choice but to pass that cash onto shareholders – a popular move in an investment environment dominated by the search for yield.

So Woodside became a “yield” stock, rivalling Australia’s banks. The problem was, this could only prove relatively temporary given either the company would find an acquisition to spend its money on or earnings, and thus dividends, would slowly reduce as production from existing projects wound down. Woodside does not pay a quantum of dividend, a la Telstra, but a payout ratio of earnings, a la the banks. Thus were earnings to fall, dividend amounts would fall, and if earnings were diverted towards acquisitions, the payout would fall.

In the former case Woodside’s yield would still look good, but its share price would fall. In the latter case, the yield would fall. But none of this takes into consideration what happens if the oil price falls.

And the oil price has fallen a long way. Woodside’s share price has also fallen a long way, which means the apparent yield has held up, and indeed risen, but only until the company resets LNG contract pricing at lower oil-indexed pricing. To put this into perspective, the FNArena database currently suggests a consensus yield expectation for Woodside of 8.7% in 2014, dropping to 6.1% in 2015. UBS points out that were it to apply current oil spot pricing to its forecasts, that 2015 yield would be 2.9% and 2016 would be 2.2%.

Did the falling oil price hasten Woodside into action?

Woodside has announced the acquisition of various stakes in oil & gas projects from US energy company Apache. These include 13% of the Wheatstone LNG project and 65% of the Balnaves oil project in offshore Western Australia, and 50% of the Kitimat LNG project in Canada which includes 320,000 acres of the Horn River and Laird unconventional gas acreage. Wheatstone is around 50% complete, is expected to deliver first gas in 2016, and is operated by Chevron. Balnaves is already producing oil. Kitimat is a long term prospect and the unconventional acreage, even longer still.

The way Goldman Sachs sees it, Woodside has acquired a producing asset in Balnaves, near term growth in Wheatstone and long term optionality in Kitimat.

The assets did not just suddenly come onto the market, they’ve been on offer since mid-year. Apache’s Exmouth oil production and WA domestic gas assets were not put up for sale, so Apache is not simply exiting Australia. Woodside did not suddenly start looking for assets, management has been scouring the globe for some time. As Macquarie notes, the deal comes despite Woodside apparently looking to diversify away from Australian LNG via greater international exposure.

So it would seem there was a level of “hurry up” in Woodside’s decision. But was it a good decision?

At an ultimate US$3.75bn price tag, the deal looks reasonable from a value perspective, brokers agree, and immediately earnings accretive given Balnaves is already producing. But is it sufficiently opportunistic? Woodside is a Big Oil company on the global scale, sitting on truck-loads of cash and little debt from its current operations, meaning it should be in the perfect position to swoop on M&A opportunities as weaker operators falter under a collapsing oil price. But the deal appears to be net asset value neutral under a long-term oil price of US$90/bbl, and oil spot prices are currently below US$60/bbl.

JP Morgan sees the deal as value accretive on its own long term price assumption of US$90. But Deutsche Bank suggests that at US$90, Woodside has not made the most of its financial strength to take advantage of current industry conditions. Macquarie calculates an oil price of US$83 is required to deliver a 10% return, “suggesting the deal comes too soon to reflect recent oil price weakness”.  In other words, negotiations have taken time and Woodside had locked itself in before the oil price really collapsed this month.

Woodside management has described the deal as a “natural fit” and aims to capture synergies and “value enhancing” opportunities. JP Morgan likes the fact the WA assets are “only a stone’s throw” from Woodside’s Pluto and North West Shelf heartland. But Balnaves is already up and running and the Wheatstone resource is already discovered/appraised, offtake deals are already largely marketed and the project is already sanctioned. “It is difficult to see,” says Macquarie, “what value WPL brings to the project other than its cash pile”.

UBS agrees that with Wheatstone development locked in and most of the LNG sold, it’s a struggle to see areas where Woodside can add value”. It doesn’t seem to fit with the company’s “value-accretive growth” mantra. “Is it just a play on oil prices?” UBS asks. Credit Suisse, similarly, suggests “it’s not clear how this acquisition fits into Woodside’s mantra of being able to add value”.

What the deal does do, as all brokers agree, is help to fill the big hole in Woodside’s growth profile. Macquarie estimates it adds around three years to the company’s proven and probable (2P) reserve life and stems annual production decline to 2% from 5% out to 2020. It basically buys management time. Then there’s the Canadian assets, but these are very long-dated propositions. Deutsche Bank sees Kitimat as a high-cost source for LNG, and notes no Canadian LNG projects have been sanctioned to date. Macquarie suspects Woodside was unable to buy the Wheatstone stake if it didn’t take Kitimat as well.

As for the included unconventional (tight/shale) acreage also thrown in, JP Morgan notes this is a left of field move for Woodside, but suggests that the difficulty in buying large-scale, quality conventional resources at the right price means Woodside would have been forced to move down this path eventually.

But now to the important question: what about those dividends?

The good news is Woodside has so much cash and so little debt that it can draw on existing facilities and fund the acquisition while still remaining at the bottom end of its preferred 20-30% gearing range. As the deal is relatively value neutral, Woodside can continue to pursue other M&A possibilities, and do all of this while still maintaining an 80% dividend payout ratio.

So that payout, which has become so popular with yield seekers, remains intact. But once again it must be pointed out that 80% of earnings depends on earnings, with regard the actual size of the dividend. Woodside earnings will fall from here on lower oil prices, given LNG prices are indexed to oil prices. Woodside’s foray into being one of the most attractive yield stocks on the Australian market was never intended to be a long one. Woodside will continue to offer a sizeable payout, at least until another M&A prospect comes along, but is still a play on capital appreciation.

That play depends on where the price of oil is going to be in the future.

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article 3 months old

Equity Strategy: Brokers Rolling Over

- Oz economic outlook softening
- Cyclical valuations pricing in strength
- Defensive valuations pricey
- Brokers in disagreement

By Greg Peel

BA-Merrill Lynch’s global investment strategists prefer stocks to bonds in the current investment environment, but see stock upside as becoming limited. Not only have valuations become less attractive, complacency has set in.

Complacency has become a growing theme of concern among investment analysts, with the most recognisable measure of risk aversion – the VIX volatility index on the S&P 500 – sitting a number below 11. The last time it was below 11 was in early 2007. The implication here is that investors are content nothing in particular is on the horizon which could upset the US equity market, and history suggests this is the typical mood just prior to something happening which does.

The more pragmatic implication is that very few investors are holding or demanding put option protection to the downside, suggesting any minor downside trigger would prompt a fall where no safety nets are in place to dampen its ferocity.

Global credit spreads are also very low at present, notes Merrills, meaning fixed income investors are prepared to accept low yielding corporate debt on the assumption risk of failure is diminished. With global interest rates so low there is a strong demand for yield which has helped to push down these risk spreads to levels which may not fully price in true risk. The good news, however, is there is nothing like the level of leverage in financial markets currently as there was pre-GFC, nor signs of blind speculation in stock markets, that could suggest a snowballing correction.

Merrills has trimmed its equity allocation by 2% and placed those proceeds into cash.

In terms of the Australian stock market, Goldman Sachs is “shifting defensive”. Last year’s RBA rate cuts have delivered a disappointing response from Australia’s non-mining economy, suggests Goldman, leaving current conditions consistent with sub-trend growth just as the fall-off in mining investment is set to become an economic drag.

But wasn’t the March quarter GDP a strong result? Only if considered in terms of real GDP growth, suggests Deutsche Bank, but not if considered in terms of the number that really matters, real income growth, which was below trend. March is now past history anyway, and conditions have softened since.

Both Goldman and Deutsche point squarely at Australia’s budget blues and the hit they have delivered to consumer confidence and retail spending. Goldman describes the response as “severe” (note today’s Westpac survey shows consumer confidence stabilising, but at the strongly negative level to which it plunged in May) and notes wage growth remains “anaemic”. Deutsche suggests retail spending is “already rolling over”.

On the corporate front, March quarter updates from listed companies were net more positive than negative but again, March is ancient history. Companies are still in cost reduction mode, notes Goldman, while Deutsche suggests investor sentiment is set to be hit if there is disappointment heading into the August result season. The issue here is that stock valuations remain elevated in general, thus not pricing in an increase in risk. Goldman also points to a still-high Aussie dollar, and warns the “peak contribution from housing may have passed”.

Consensus suggests rising revenues and margins for Australian companies ahead. Goldman believes ongoing cost reductions will continue to provide earnings support but sees significant earnings risk for cyclical industrials and miners.

The only real upside valuation case one can make for the Australian market (from a local and global perspective) at present is yield says Goldman, and the broker sees few risks to dividends. So rather than exiting to cash the Goldman strategists are advising a switch to defensive stocks for which yield is secure.

This is not easy given elevated valuations for yield stocks in particular, but Goldman likes the opportunity provided by infrastructure and singles out Spark Infrastructure ((SKI)) and DUET ((DUE)) as offering a rare combination of solid yield (6.5%+) and low cyclical economic exposure. Otherwise the broker identifies Goodman Group ((GMG)), QBE Insurance ((QBE)) and Flexigroup ((FXL)) as stocks to add and Transurban ((TCL)), Lend Lease ((LLC)), SFG Australia ((SFW)) and SAI Global ((SAI)) as stocks to sell out of, with the latter three all currently offering M&A premiums. Transurban’s road tolls are more economically sensitive than utility infrastructure such as gas pipes.

Deutsche disagrees with Goldman on housing, suggesting that while building approvals have fallen recently, they have only fallen for apartment blocks which are less material-intensive per dwelling than houses. Previous strong approvals readings suggest there is plenty in the construction pipeline. Deutsche also suggests the Australian consumer could well “get back on track” later this year (presumably after budget shock wanes) which would thus prompt businesses into restocking and investment.

Deutsche is hanging onto its housing sector allocations, but like Goldman is Overweight defensives, specifically general insurers, REITs, utilities and healthcare. The broker is Underweight miners but Overweight LNG.

Yesterday Morgan Stanley joined a handful of others suggesting the Aussie dollar could return to parity by year-end. Deutsche’s forecast remains US85c, on the belief US bond yields look now to have bottomed. A lower currency is a positive for Australian equities (but rising bond yields would impact on high-yield defensives).

UBS is also anticipating a bond sell-off (rising yields) in coming months, and also forecasts an Aussie of US85c by year-end. UBS is thus in disagreement with Goldman, given UBS remains Underweight yield. The broker is also in direct contrast in highlighting Transurban as its stand-out yield preference.

Thereafter the division is less clear, with UBS also favouring QBE Insurance along with ResMed ((RMD)), CSL ((CSL)) and Crown Resorts ((CWN)).

Among the most obvious chasers of yield are Australian Self-Managed Super Fund trustees. The bell has just rung as the SMSF cohort welcomes its one millionth member, and Credit Suisse notes SMSFs have increased their average equity allocation over the past twelve months by 1.1 percentage points to 43%. SMSFs own 16% of the Australian equity market.

SMSFs are by their nature diligent savers and conservative investors, notes Credit Suisse, with a median age in the early sixties. Conservatism stems from being close to “harvesting” their retirement investment and it is of no surprise high-yield stocks are favoured. SMSFs have grown their assets under management more than fivefold in a decade (reflecting new SMSF’s, not 600% returns).

For those investing/trading outside the superannuation sphere, SMSFs offer a sneaky exploitation opportunity, Credit Suisse implies (albeit in not so many words). Given a lower risk tolerance, they buy stocks with attractive yields but not necessarily stocks with the potential to raise their dividends, and thus yields. The trick is thus to by the latter now, and sell to the SMSFs when they catch up on increased dividends.

Such an opportunity exists, Credit Suisse suggests, in Caltex ((CTX)), Fairfax Media ((FXJ)), Flight Centre ((FLT)), Myer ((MYR)) and Perpetual ((PPT)).

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article 3 months old

The Overnight Report: Nasdaq, Russell Fight Back – Again

By Greg Peel

The Dow closed up 20 points or 0.1% while the S&P gained 0.4% to 1885 as the Nasdaq rose 0.8%. The Russell 2000 rose 1.0%.

It started in the iron ore stocks yesterday but it soon spread like wildfire across the wider Australian market. Another US$2.20 drop in the iron ore price overnight to US$98.50/t, below the psychological 100 mark, does not bode well for the materials sector again today. Yesterday, however, it was not just about China but about Tony. Rarely do politicians have any meaningful impact on the stock market, but yesterday’s popularity polls suggested a big drop in Australian consumer confidence ahead.

And that translates through the system, from retailers to banks and beyond. While the materials sector led with a 1.9% loss yesterday, consumer discretionary (-1.5%) and banks (-1.1%) were also hit. Banks (and other financials) represent about 40% of the ASX 200.

Not helping yesterday was news from China that eight major cities saw house prices declining in April when only four saw declines in March. Is the Chinese property market rolling over?

Put it altogether and Bridge Street had one of its familiar snowballing sell-offs yesterday, which tend to happen quite regularly when someone says “overvalued”. At this stage the SPI Overnight is pointing to a 20 point rebound today, but the SPI Overnight is not always an accurate predictor.

Over on Wall Street, the Dow opened down 50 points. It was to prove to be, nevertheless, one of the lowest volume trading days of the year. A lot of factors were hanging in the balance by the end of last week. Would the Russia-Ukraine tension escalate or ease? Was the US ten-year bond yield about to break technical support and rush towards 2%? Was the momentum stock and small cap sell-off still only in its early stage? All these factors have Wall Street nervous at present. Traders covered shorts late on Friday, sending the Dow rallying 50 points to its closing level, and apparently re-established them from the bell last night, having moved to the sidelines for the weekend.

There were no data releases to speak of to contemplate early in the session. But right from the opening drop, the Nasdaq started to rally. And the Russell started to rally. The S&P was helped up by the Nasdaq and after a spluttering start, the blue chips began to follow suit.

A firm eye was kept on the ten-year bond yield. It too began to rise, ultimately closing up 2 basis points to 2.53%. It’s not a big reversal, but it is a reversal so far. Then everything fed on itself. It’s not unusual for stock traders to say stocks went up because bond yields went up and for bond traders to say bond yields went up because stocks went up.

Whatever the case, the lack of volume renders last night’s session relatively ineffective as a trend indicator. We may need to wait for Wednesday night’s Fed minutes and Yellen speech and data releases later in the week to gauge what will happen next.

The US dollar index remained steady at 80.03 and gold remained steady at US$1293.00/oz. The Aussie is 0.4% lower at US$0.9328 on the China/iron ore factor, and on yesterday’s stock selling by foreigners, one presumes.

Volumes were also very low over on the LME, similarly providing a vacuum for price rallies. All metals rose around half to one percent except for nickel. Having been thumped about 10% in recent sessions, nickel rebounded again last night by a quiet 6%.

Spot iron ore, as noted, fell US$2.20 to US$98.50/t.

The oils were split between a US43c drop for Brent to US$109.32/bbl and a US60c rise for West Texas to US$102.62/bbl.

The SPI Overnight, as noted, closed up 20 points or 0.4%.

The minutes of the May RBA meeting are due out to today but as they are cum-budget, they lack relevance. Arrium ((ARI)) will report its quarterly iron ore production today – timely – while Transurban ((TCL)) will provide an update.

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article 3 months old

The Overnight Report: It’s All Ups And Downs

By Greg Peel

The Dow closed up 32 points or 0.2% while the S&P eased 0.1% to 1875 as the Nasdaq fell 0.4%.

The market taketh away and the market giveth. On Tuesday night the Dow fell over 100 points and on Wednesday night it rose over 100 points. On Wednesday the ASX 200 fell 40 points and yesterday it rose 40 points. On Wednesday you couldn’t give away a bank or an iron ore miner and yesterday you would have been bowled over in the rush. Yet the NAB result was a touch on the low side and the iron ore price fell. On Wednesday the retail sales number was weak and yesterday the jobs number was strong, but economics are only a distraction in a thin market.

Yesterday’s Australian April jobs number was one of the cleanest and most positive for some time. Gone were the wild head-scratch numbers of earlier in the year to be replaced by a more sensible 14,200 addition. There were several encouraging aspects to the report: (1) the unemployment rate remained steady at 5.8% when a rise to 5.9% was expected; (2) the participation rate was also steady, meaning the “beat” on the unemployment rate had nothing to do with people leaving the workforce; (3) all of the net gain was in full-time jobs for once, with part-time jobs remaining flat; and (4), despite the steady unemployment rate, the RBA’s closely watched trend in unemployment has now turned negative (or if you like, trend in employment has turned positive).

In its April statement the RBA suggested “The demand for labour has remained weak and, as a result, the rate of unemployment has continued to edge higher. It will probably rise a little further in the near term”. This week’s May statement was a tad more positive: “The demand for labour has been weak over the past year and, as a result, the rate of unemployment has risen somewhat. More recently, there has been some improvement in indicators for the labour market, but it will probably be some time yet before unemployment declines consistently”.

Yesterday’s result will potentially lead the central bank to believe unemployment may have peaked earlier than it had previously assumed. The turn in trend may yet prove a head-fake but the sort of numbers some economists were forecasting at the beginning of this year – such as a peak of 6.5% in 2015 – look a little bearish. This result alone will not spark a rate rise, but it’s another piece in the puzzle.

China’s April trade balance hit the wires about the same time yesterday. It showed a further push back into surplus following the brief lunar new year-impacted foray into deficit in rising to US$18.45bn from US$7.71bn in March and beating expectations of US$13.9bn. Having fallen 6.6% in March, analysts had expected Chinese exports to fall 3.0% in April but instead they rose 0.9%. Imports fell 11.3% in March and analysts expected a fall of 2.1% but they rose 0.8%.

So China provided reasons to be cheerful, part two, but realistically we’ve seen a lot of volatility in the local market of late but no meaningful shift out of the 5400-5500 range while similarly Wall Street has been flying around just below all-time highs and effectively going nowhere.

Last night the Dow rose steadily from the bell on easing Ukraine tensions, positive China data and a decent read on US chain store sales, to send the Dow up 104 at lunchtime and into fresh blue sky. By 3pm, the Dow was slightly negative. At 4pm, it closed up 32, below the all-time high. The Nasdaq again proved a drag, with last night’s momentum victim du jour being electric car maker Tesla, down 11% after offering weak guidance.

Another positive lead for Wall Street from the bell came from ECB president Mario Draghi after last night’s ECB policy meeting. Prior to the meeting, forex traders pushed up the euro in an attempt, it would seem, to taunt Draghi into actually acting on his now hackneyed threats to ease policy in order to cap the currency, likely presuming he would cry wolf yet again. So when Draghi said he would be “comfortable” acting June if needs be – the first time an actual timeframe has been suggested – the euro tanked. ECB easing would flow through to positivity globally, assuming you’re a QE fan this late in the game.

Many aren’t of course, which is why we have this unfamiliar dichotomy on Wall Street of a bullish stock market and a bearish bond market (in economic outlook terms). Or is there a simpler explanation? Surveys suggest almost three quarters of those investing for retirement in the US would rather put their money into cash instead of a stock market which blew them away six years ago. A thirty-year government bond will get you 3.4% while cash will get you little more than zero (ie negative real).

The US dollar index rose 0.3% to 79.44 last night on the euro’s fall, the US ten-year yield was steady at 2.60%, gold was steady at US$1289.20/oz and the Aussie has risen 0.4% to US$0.9369 on the positive local jobs number.

It was fun and games in metals last night. The LME closed with Wall Street at its highs, which was provided as the reason all base metal prices were positive rather than the Chinese trade data. Copper was up 1%. One might have assumed a bit of the Russia-sanction premium could have come out of nickel last night given Putin’s apparent back-down, but we’ll never know because Vale announced it had suspended production at its nickel mine in New Caledonia. You might be forgiven for thinking New Caledonia is hardly the nickel capital of the world. The LME nickel price jumped 4%.

On the other hand, iron ore fell US$1.40 to US$103.70/t.

The oils were relatively steady, with Brent down US11c to US$108.01/bbl and West Texas down US48c to US$100.29/bbl.

So we had a flattish session on Wall Street and mixed messages from commodities. The SPI Overnight is up 3 points. Looks like a Friday.

China’s inflation data are out today while the RBA will release its June quarter Statement on Monetary Policy. JB Hi-Fi ((JBH)) will provide a trading update.

After the bell on Wall Street, News Corp ((NWS)) posted a positive result and its shares are up 2% in the after-market.

All overnight and intraday prices, average prices, currency conversions and charts for stock indices, currencies, commodities, bonds, VIX and more available in the FNArena Cockpit.  Click here. (Subscribers can access prices in the Cockpit.)

(Readers should note that all commentary, observations, names and calculations are provided for informative and educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views expressed are the author's and not by association FNArena's - see disclaimer on the website)

All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.

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