Much of the investment community is focused on taking advantage of the “post-covid trade”, further investigation is required when looking at stocks trading at decent valuations paying attractive dividends. Dividend paying stocks can be “value stocks” that have been significantly mispriced because of the pandemic.
Rationale for dividend stocks include:
- The cash rate is expected to remain lower for longer: the Reserve Bank of Australia has moved the cash rate to new historic lows of 0.1%. Further, the RBA’s Monetary Policy Decision dated 3 November 2020 noted “given the outlook, the Board is not expecting to increase the cash rate for at least three years”. Indeed, yields on all asset classes have fallen. Hence the dividend yield differential to the cash rate is expected to widen.
- Take advantage of the Australian Tax system: Investors, can take advantage of mechanisms associated with the Australian tax system (and dividends, franking credits, special dividends and off market buy-backs).
- Fundamentally sound: Stocks with the option to undertake capital management initiatives such as payout dividends often have strong balance sheets, earnings and cash flow. Coupled with attractive valuations, these are the types of stocks which can form core to any portfolio.
Positive on Banks, Iron Ore Miners and Consumer Staples, whilst selective regard REITs:
- Banks (POSITIVE). The recent results announced by Australian domestic banks have reflected provisions for loan losses once vigilantly made shortly after the advent of the Covid-19 pandemic have now begun to reverse and the cautious regulator in APRA have now removed their guidance for Australian banks to limit dividend payments. In our view, the reduction in provisions means that Australian banks are well positioned from a balance sheet/capital perspective and well placed to undertake capital management initiatives, such as a return to pre-Covid-19 dividend levels.
- Iron Ore Miners (POSITIVE). Prices for iron ore (with a 63.5% iron content) have extended gains to above US$200 a tonne on the prospect of easing production restrictions of steelmaking in Tangshan, China and a failure of Chinese measures to contain the rapid surge of prices for industrial commodities. Whilst several market analysts have come out in the past month to signal an end to the phenomenal iron ore price performance, we are more skeptical and are not yet this pessimistic. For us, we believe the debate is deeper than simply tensions between China and Australia – it is about supply and demand. In our view, demand for high-grade iron ore remains robust and the supply remains tight and impact on iron ore prices from prospective mines in South America and Africa are a longer dated issued (at least 2025).
- Consumer (POSITIVE). As a result of lockdown measures, we have seen a significant shift in consumer behaviour and indeed a shift in earnings between different sectors. We are positive on consumer stocks which have benefitted from the shift to “work from home”, “play at home” and “eat at home”, as well as the shift from bricks and mortar (in-store) to online consumption.
- REITs (NEGATIVE). With lockdown measures seeing office workers working from home, and retailers forced to close their brick-and-mortar presence (and indeed downsize their physical store network), we are concerned over structural impacts to property fundamentals to both Office and Retail REITs, such as rents, demand for space and hence the impacts on asset valuations.