High-yield, low-payout stocks stand out

Strategy tends to outperform others in most rising markets

INVESTING in stocks that offer high dividend yields but pay out only a small proportion of their earnings tends to outperform other strategies in the long term, according to Credit Suisse analysts.

‘High-yield, low-payout essentially means you are buying yield stocks that are trading at a low price-earnings ratio’, or value stocks, its analysts said in a report on Asia-Pacific equities last week.

Such an investment strategy tends to outperform others in rising markets except in the bubble phase, they said. Also, ‘a low payout implies that these companies are retaining cash for growth which also helps long-term performance’.

They analysed stocks in Asia-Pacific markets for the best-performing strategies during the period January 2009 to June 2010.

In Australia, China, India, Indonesia, Japan, Malaysia, South Korea and Taiwan, buying high-yield, low-payout stocks would have earned investors the highest returns over that period compared with other strategies, they found.

The other strategies tested included buying stocks that paid no dividends; stocks that had high dividend yields; stocks with both high dividend yields and high payout ratios; stocks with low dividend yields and low payout ratios; and stocks that had low dividend yields but high payout ratios.

The performances of the various strategies were also compared with that of buying an overall portfolio of stocks for each market.

‘For most markets, the high-yield low-payout strategy was the best performing strategy followed by the non-dividend paying stocks for a few markets,’ the analysts said.

Stocks that pay no dividends are also called growth stocks. Instead of seeking dividends, buyers bet that the share price will increase substantially so they get large capital gain when they sell the stocks.

In Singapore, stocks that paid no dividends showed the biggest returns over the period examined. But investing in high-yield, low-payout stocks was still the best-performing strategy over a longer period of 15 years examined in an earlier study, the Credit Suisse analysts said.

Among those they consider to be high-yield, low-payout Singapore stocks are telco M1, rig builders Keppel Corp and Sembcorp Marine, transport group ComfortDelGro Corp, real estate developer Allgreen Properties and conglomerate Sembcorp Industries.

These stocks have dividend yields of up to 6.3 per cent a year at current prices but pay out as little as one-third of their profits as dividends. All are rated ‘outperform’ by Credit Suisse.

Other stocks, such as Fortune Real Estate Investment Trust and property firms MCL Land and United Engineers, have dividend yields of over 3 per cent a year but pay out less than a quarter of their earnings as dividends.

Dividend payouts likely to fall in ’09: UBS analysts

They say ‘slash & burn’ across the board is unlikely, sound positive note about banks

DIVIDEND payouts are declining in Singapore but deep cuts in payouts across the board are not likely, said UBS Investment Research.

‘We expect selected sectors and stocks to substantially cut dividends, but overall a ‘slash & burn’ in dividends across the board appear unlikely,’ said the firm in a March 13 report.

The firm said that property stocks and loss-making companies are where investors should have least confidence on dividend forecasts.

By contrast, ‘staples’ such as Singapore Post, (SingPost) StarHub, MobileOne (M1) and SMRT are stocks where confidence should be highest.

UBS also noted that for the offshore-related stocks, special dividends run the risk of being fully eliminated in 2009.

‘This is especially so as management is looking out for acquisition opportunities as the cycle deteriorates,’ noted analysts Tan Min Lan and Ling Vey Sern.

In addition, they said that for some stocks with high projected payout ratios (Singapore Technologies Engineering, Singapore Exchange, Venture Corp and Singapore Airlines) the obvious risk lies with potential earnings per share (EPS) disappointment.

The research report also identified Singapore Press Holdings (SPH) as having the biggest risk of cutting payout (to a dividend yield of about 8 per cent) among the ‘yield stalwarts’.

UBS also warned that for the real estate investment trust (Reit) sector here, the timing and size of potential fund raisings remain a risk to dividend yield forecasts.

However, the firm’s analysts also sounded a positive note about companies in one sector here – banks. ‘Banks have articulated a desire to signal their financial strength by largely maintaining payout,’ UBS noted, adding that a 4-6 per cent dividend yield range looks sustainable for the sector.

To assess dividend sustainability, UBS analysed earnings risks, compared free cashflow (FCF) yields to estimated dividend yields, and calculated what the estimated 2009 dividend yields would be if payouts were cut to the lowest level since 2001.

Meanwhile, for stocks with outstanding corporate bonds, the firm compared the respective dividend yield and bond yield.

‘Our view is that the recently concluded reporting season provides good insights into management intentions regarding future dividend decisions,’ the note concluded.

For example, in the recently concluded fourth quarter 2008 earnings reporting season, companies that suspended final dividends because of quarterly losses included Hong Leong Finance and Parkway Holdings.

And companies that eliminated or significantly cut ‘special dividends’ included CapitaLand, City Developments, Keppel Corp, Sembcorp Industries, Sembcorp Marine and ComfortDelGro.

Other companies, such as NOL and CDL Hospitality Trusts, revised stated dividend policies.

However, some other firms gave their investors reasons to be hopeful.

Companies that reiterated their commitments to a payout ratio include ST Engineering (100 per cent), CapitaMall Trust (100 per cent), CapitaCommercial Trust (100 per cent), SingPost (80-90 per cent, subject to a minimum of five cents), M1 (80 per cent), OCBC (45 per cent) and UOB (40-60 per cent).

And there were also companies with no stated payout ratio, but where the management communicated a strong intention to maintain or largely maintain the dividend per unit or payout.

These included SMRT, StarHub, DBS, Venture Corp and Parkway Holdings.

Dividend-rich story is waning

IT MAY be a nag but a mother’s reminder of ‘safety first’ to her kids is pretty good advice.

And in such uncertain times, people are turning maternal. They are looking for investments that they can nestle into and sleep soundly over.

Ordinarily, this would refer to dividend-rich stocks such as those in the banking, oil and gas, and the telecommunications sectors.

Which explains why several blue chips tend to find favour among analysts. Besides the assumption that shareholders are buying into an established and stable business, the stocks yield attractive dividends for shareholders.

This is despite (or a consequence of) them typically being more expensive in dollar terms compared with other stocks on the market.

But the dividend-rich story that some analysts still keep up is waning.

Oil and gas kingpin Keppel Corporation slashed its dividend payout ratio last month to 51 per cent from 99 per cent a year ago, despite posting a slight 3 per cent dip in full-year net profit to about $1.1 billion.

And while competitor Sembcorp Marine is prepared to push out a dividend of 11 cents per share for the full year, 26 per cent higher than the 8.73 cents paid in 2007, the company has noted that the dividend policy is not cast in stone. This signals that future dividends for the company could be shaved to explore mergers and acquisitions (M&A) opportunities or as a precaution against the credit crunch, as banks turn coy on lending.

Over in the US, JPMorgan Chase became the latest bank to cut dividend payout. It lopped dividend payout by 87 per cent to five US cents per share from 38 US cents, saving US$5 billion in capital per year from the reduction, reported Bloomberg. This is despite the bank expecting a profit in the first quarter in 2009 that is aligned with analysts’ estimates.

Banks at home – which are assumed to be stronger than their Western counterparts – have maintained their payouts so far. But OCBC has plans to introduce a scrip dividend scheme that allows shareholders to receive the latest dividend in the form of shares instead of cash, which is seen as a means to conserve capital.

Even the real estate investment trusts (Reits) sector, which rests on a stable income distribution as its selling point, is not as resilient as some analysts make them out to be.

Saizen Reit yanked distribution payout for its fiscal second quarter and has proposed a scrip-only dividend scheme, under which it would pay dividends in the form of Reit units instead of cash.

CDL Hospitality Trusts also said that it would distribute 90 per cent of its taxable income – the minimum amount of distribution – for the second-half 2008, compared with off-loading 100 per cent of its taxable income. This would save the company about $4 million.

Analysts say that the ‘scrip-only’ scheme and other dividend reinvestments schemes are being mulled by other Reits as well to hoard cash. This is especially as the situation of debt maturity appears ‘more acute’ here compared to other Reits in the region, said DBS Vickers Securities in a recent report, with about $3.2 billion or 24 per cent of the total sector indebtedness being due for refinancing this year.

The bottom line is that stocks that paid out generous dividends in past may not necessary do so now.

Measures to crimp dividend payouts are understandable. While there is little doubt that shareholders will lose out in the short term, it would be unwise for companies to pay out cash, or worse, to borrow (at much higher costs now) and risk future operations by weakening its cash position.

But this means that stocks that were once lauded as safe, resilient or defensive based simply on their dividend yields, may no longer be seen as such.

Lower dividends on the cards as earnings wither

But blue chip companies likely to maintain payout ratios

Investors could receive lower dividend payouts in absolute dollar terms this year as corporate earnings wither under the heat of the recession.

Still, investors can take heart that yields will still remain at attractively high levels, given the low valuations and the fact that most companies are not planning to cut their dividend payout ratios yet.

Not all companies have fixed their dividend policies but the blue chip firms that BT spoke to say they are likely to maintain the status quo.

‘We will continue to reward our shareholders with dividends as long as free cashflow is not required for acquisitions and strategic investments,’ said a ST Engineering spokesperson. The group paid out 100 per cent of its net earnings as dividends for the fifth year during fiscal 2007.

Keppel Corp spokesperson told BT that the group aims to distribute around 50-60 per cent of its full year Patmi (profit after tax and minority interest) annually as dividends to shareholders.

Agricultural commodities supplier Olam International has a dividend payout policy of 25 per cent of NPAT (net profit after tax) and says it does not expect any significant changes to its policy as it expects to meet its earnings target for fiscal 2009.

‘Given that our business fundamentals are quite strong and our belief that agricultural commodity sector remains attractive due to structural reasons, we expect to deliver long-term shareholder value,’ said an Olam spokesperson.

Analysts note that thanks to their strong cash positions, most blue chips still have the staying power to stick to their dividend payout policies.

‘The good dividend-paying sectors have always been the banks, the offshore marine sector and the telcos and in these sectors, I think the ability to pay is still there,’ CIMB-GK research head Kenneth Ng said.

He noted that earnings of banks may fall this year, but not to the extent that it would jeopardise dividend payouts. In fact, during the Asian financial crisis, the banks maintained their dividends, he recalled.

OCBC head of corporate communications Koh Ching Ching told BT that the bank maintains a minimum dividend payout of 45 per cent of its core earnings. For fiscal 2007, OCBC paid out 28 cents per share or 46 per cent of its core earnings as dividends.

While companies that will maintain their payout ratios stand to earn kudos, the harsh operating climate has prompted the market to already price in the prospect of lower dividends on the back of weaker earnings expectations.

JPMorgan analyst Christopher Gee noted that valuation models imply that Singapore stock dividends will drop 20 per cent in the next year or fall by 2.2 per cent per annum over the next 10 years.

He believes stocks in the financial sector – both banks and real estate stocks and notably the S-Reits – are the most likely to lower their dividend ratios due to weaker earnings or equity dilution from refinancing exercises.

‘Stocks in cyclical sectors with fixed payout ratios are also likely to see reduced dividends, with SIA and the commodity-related names the most likely to reduce dividend payouts in our view,’ Mr Gee said in a recent report.

Some companies may choose to reduce their dividend payouts to conserve cash in a difficult year or seek M&A opportunities, Mr Ng of CIMB-GK added. This is especially so given that many companies’ share prices are beaten down, and can still offer a high yield despite a lower dividend payout.

While recent concerns about debt refinancing and recapitalisation needs have sent prices of S-Reits south, some S-Reit managers told BT they are keeping to a 100 per cent distribution payout, above the 90 per cent minimum required under regulatory guidelines. Some Reits have also secured their refinancing needs for this year.

‘For 2009, Parkway Life Reit intends to continue to maintain its distribution payout at 100 per cent,’ said Yong Yean Chau, acting CEO and CFO of Parkway Life Reit.

He added that Parkway Life Reit has secured all its financing needs by replacing short-term credit facilities with longer-term facilities and has locked in long-term master leases for its properties.

Suntec Reit chief executive Yeo See Kiat said the Reit’s next refinancing will not be due before December 2009 and he does not expect to see a major fluctuation in distribution payout.

Analysts suggest that some companies may vary their payout ratios to maintain their absolute dividend sums.

JPMorgan’s Mr Gee is expecting payout ratios of Singapore companies to rise to 58 per cent in fiscal 2009, up from an average payout ratio of 53 per cent between 2000 and 2007. This will translate to a yield of 6.59 per cent.

For fiscal 2008, which has just ended, StarHub has committed to paying an absolute dividend sum of 18 cents per share, up from 16 cents in fiscal 2007, while SingTel and Mobile- One said they might review their payout ratios.

‘Unlike other companies, we do not have a payout ratio for our dividend – it has always been on absolute level,’ a StarHub spokeswoman told BT. ‘We are a free cashflow-focused company. We don’t believe in paying dividends based out of our earnings.’

A Singapore Exchange (SGX) spokesperson said the company aims to pay dividends no less than either 80 per cent of the annual NPAT or 14 cents per share, whichever is higher. It paid total dividends of 38 cents per share for the fiscal year ended June 30.

Investors may also find some comfort in the projections by Morgan Stanley analysts – that dividend cuts will be much smaller than earnings declines. This was what happened during the Asian financial crisis of 1997/98, when Asia-Pacific (ex-Japan) EPS fell 73 per cent peak-to-trough, but dividends per share declined by just 20 per cent.

The concerns notwithstanding, these analysts suggest that for long term investors, a wide gap between dividend yields and bond yields should serve as a ‘strong buy’ signal for dividend-yielding stocks.