Friday 29 Mar 2024
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This article first appeared in The Edge Malaysia Weekly, on March 7 - 13, 2016.

RISING dividend payments are traditionally equated with balance sheet strength, but the smart investor knows that is not always the case. Some learnt the hard way, having bought into companies that were paying shareholders using future earnings and borrowings instead of just returning excess cash.

Others knew some dividend streams were unsustainable but bought the stocks anyway because of their thirst for yield during times of ultra-low interest rates. They helped chased prices of these so-called “quasi cash cows” higher but not all escaped with profits when reality dawned.

Investors who have wised up are questioning the sustainability of dividends as growth gets tougher to find amid rising costs and industry-wide landscape changes, which threaten future earnings that are needed to fuel continued dividend payments.

A stretched balance sheet (read high net debt) is another clue that historical increases in dividend payments are no assurance of dividend payments going forward.

Yield stocks remain sought after even as the world grapples with the impact of negative interest rates. And investment premiums have risen considerably, just over seven years after the US Federal Reserve announced its first quantitative easing (QE1) programme in late 2008.

In Malaysia, there is added reason to seek safety in dividends.

“An uptick in political uncertainties” following Tun Dr Mahathir Mohamad’s resignation from Umno “could dampen the ringgit’s positive momentum”, UOB Kay Hian Malaysia head of research Vincent Khoo says in a March 2 note. He advises clients to “stay defensive and focus on dividend yield plays”.

His list of attractive quality high-dividend yielders includes Malayan Banking Bhd (Maybank), Hong Leong Industries Bhd, IGB REIT and Carlsberg Brewery Malaysia Bhd, with yields ranging from 5.9% to 6.3%. UOB Kay Hian also has a “buy” on Guinness Anchor Bhd.

Meanwhile, Maybank Investment Bank Research tells its clients that 2016 earnings could be down 2% for Guinness Anchor and 2.7% for Carlsberg on the assumption that volumes will contract 0.3% (the same quantum as 2003 when excise duty was raised 10%) due to an expected tax hike on alcohol from March 1. Its report, also dated March 2, forecasts a dividend yield of at least 6% for Carlsberg (“hold”, RM13 target price) and Guinness Anchor (“buy”, RM15 target price), with no change in expectations “pending further clarity from management”.

The tax hike, while expected, is one example of how earnings — and in turn dividend payments — could be affected by operating changes.

A quick search found 140 stocks that have above the FBM KLCI’s 3.4% average yield for 2017 (3.16% for 2016), according to Bloomberg data at the time of writing.

Of these, 62 have yields above 5% and these include the five stocks mentioned so far: Maybank (5.85%), Hong Leong Industries (5.61%), IGB REIT (5.62%), Carlsberg (5.87%) and Guinness Anchor (6.46%). The last is among only 30 companies with above 6% yield, Bloomberg data shows.

Those familiar with Bloomberg knows it has proprietary analytic functions and limitations. And the yield figures cited here is largely a function of consensus analyst forecasts, coupled with the latest historical reported financial figures, which may not be reflective going forward if the companies’ balance sheets are stretched or if there is a significant change in operating conditions or inherent competitiveness.

That is not to say these figures cannot be relied upon, but rather, that investors need to do a lot more work to be certain that the yields they want will continue to come.

Even the “safe bet” Telekom Malaysia Bhd — the only stock on Bursa Malaysia that has a minimum dividend payout promise of RM700 million or up to 90% of its annual profits — is going through a rough patch as it puts its foot back into the mobile business, a segment spun off into the current Axiata Group Bhd in 2009.

For now, due to confidence in the dividend promise, yield has compressed to 2.87% at its RM6.63 close last Thursday, assuming its payout falls nearer to RM700 million (19 sen per share) this year. Yield was 3.11% on the same assumptions at its recent low of RM6.10 a share last August.

There will be periodic market imperfections, but as the maxim goes, higher gains often come with higher risk.

It is worth noting that seven of the 12 stocks with yields of above 7% (according to Bloomberg data) are real estate investment trusts (REITs), which need to pay out over 90% of their earnings as dividends in order to get tax pass-through benefits.

Simply put, whatever their real cash needs are, REITs have to pay out 90% of its annual profits to avoid paying corporate tax — just one exception to the adage of consistent dividend payers being cash-rich companies.

While REITs can provide stable cash flow, they can be faced with a dilemma when their assets age and need refurbishment if costs are higher than their cash reserves — one which can lead to asset sales or a rights issue.

Business trusts, which do not have a minimum dividend threshold but are allowed to pay them even without having profits, would fall under a similar category of dividend payers that are not necessarily cash rich. Rather than a reward to shareholders, these dividend streams can, at times, be likened to interest payments.

To be sure, the well-managed ones can go on for a long time and their chances are higher if the underlying assets are those that can appreciate in value rather than those with a straight-line depreciation with a definitive end-life. But even the latter can provide a learned investor with decent returns in the initial years.

Media companies — broadcaster and publisher Media Prima Bhd and Star Media Group — are also among the stocks with yields of over 7% at the time of writing. Media Prima’s portfolio contains the country’s free-to-air TV and radio stations plus three national newspapers — New Straits Times, Berita Harian and Harian Metro. Star Media’s mainstay is The Star English newspaper.

The good news is that both companies are still in a net cash position, with the caveat being the challenges the industry is going through as consumption patterns change due to technology and the ubiquitous internet. Both companies, like many others, are reining in overhead costs while investing in new sources of growth.

It is worth noting that both Star Media and Media Prima have been paying out at least 50% of profits since FY2011, according to Bloomberg data.

While past payment track records may not necessarily reflect ability for future payments, the assumption here is that companies that have consistently been making over 50% payouts and are still in a net cash position or have low net debt, should be able to continue to make generous payments. Others will have to work harder to replenish their cash positions.

There are about 40 companies with yields of over 4% that have been paying out at least 50% of their profits as dividends for at least three of the past five fiscal years, a quick search on Bloomberg shows (see table).

Of these companies, a number are still in a net cash position while at least eight of them have over two times net debt to earnings before interest, tax, depreciation and amortisation (Ebitda), according to Bloomberg data. The latter are MRCB-Quill, YTL Corp Bhd, CapitaLand Malaysia Malls Trust, YTL Hospitality REIT, Boustead Holdings and Lingkaran Trans Kota Holdings Bhd.

On the other hand, those with more than two times net cash to Ebitda include Bursa Malaysia Bhd, SHL Consolidated Bhd, Star Media, Uchi, Apollo Food Holdings Bhd, Amway Malaysia Bhd and Elsoft Research Bhd.

When recently asked for guidance on yield, RHB Research Institute executive chairman and chief economist Lim Chee Sing says investors’ focus should be on “stocks with improved business model, reasonable earnings visibility, strong cash flows, a dividend policy put in place and, hence, sustainable dividend payments”.

“Of course, one cannot ignore valuations as well, as rich valuation stocks are still susceptible to selldowns should global economy take another turn for the worse,” adds Lim. These words are worth pondering over as one seeks out the right defensive stocks to bolster his portfolio.

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