Australia’s top yield stocks

Running a dividend yield fund shines a light on the good, the bad and the questionable on the ASX.

Summary: Investors have a host of blue-chip yield alternatives to choose from on the sharemarket, from the big banks to retailers, resources stocks and infrastructure.
Key take-out: A golden rule for investors chasing yield is to select companies that have a consistent and maintainable dividend record.
Key beneficiaries: General investors. Category: Shares.

The yield chase which dominated the markets over the last year is far from over: Indeed as local cash rates keep falling, the search for yield beyond the narrow confines of term deposits continues apace.

And whether they like it or not for most investors the main arena for yields in the local retail market is the ASX. In recent times I have been involved in managing an income fund that focuses strictly on the best ASX-listed stocks for dividend yield.

In other markets, the US for instance, a long held investment aphorism is that stocks (i.e. shares) are for capital growth, while bonds are for yield. This may be fine when bonds return to paying 3-4% per annum; but in the current low interest rate environment, investors can and should use equities as a means of generating income.

Thanks to the desire of many listed companies here to return profits to shareholders, strong and tax-effective yields can still be achieved from the local market.

Before I get into which individual shares to select, the important general rules for my equities yield fund are as follows:

  1. All stocks must form part of the S&P ASX100 Index (the ‘Index’). In fact, as I run a separate fund that writes call options against shares for additional yield (more on that at a later date), all of my holdings must be in the top 60 stocks, as these are the only ones against which the ASX quotes options.
  2. Companies selected must have a consistent and maintainable dividend record. Although BHP is hardly a high-yielding stock, for example, the company does have a long track record of never cutting its dividend, irrespective of external circumstances. Telstra is another example of this.
  3. Franking credits are taken into account. Because super fund investors generally receive a cash rebate for unused franking credits, I feel it appropriate to gross up all yields.
  4. Borrowing to pay dividends – companies that do this for too long will eventually come a cropper unless their earnings catch up.
  5. Special dividends are generally not taken into account, as these cannot be counted upon in future years.

So, what stocks currently form the basis of my yield portfolio?

The Banks – I generally hold the “big four” banks at around 150% of their total market weighting in the index. In addition, I keep their relative weightings in the portfolio at very similar levels to the index. Although I feel that the golden era of double-digit annual profit growth is now well behind the big four (ANZ, Commonwealth Bank, NAB and Westpac), their desire to placate investors with both a high payout ratio, accompanied by full franking, means that they must form the core of any decent yield portfolio.

I tend to avoid the second tier banks, as their results are too prone to nasty surprises (although arguably NAB has been guilty of this too in recent years). For this reason I do not hold Suncorp Metway, despite its seemingly attractive dividend yield.

FY14 Est. Dividend Yields:

ANZ

5.6%

Commonwealth Bank

5.2%

NAB

6.1%

Westpac

5.9%

Telstra – Even when it share price was languishing at the $2.85 mark a couple of years ago, Telstra’s board stuck to its guns and maintained its 28 cent annual fully franked dividend. Fortunately for yield investors, the company’s earnings have eventually caught up, and Telstra no longer has to borrow for this purpose. As the NBN cash flows hit the company’s balance sheet over the next few years, I expect the cash dividend to increase.

FY14 Est. Dividend Yield:

Telstra

5.9%

Resource Stocks – It may seem odd to include traditionally low yielding and high capex spending resource companies in a yield portfolio. Woodside Petroleum, however, is a good example of what can occur when a company’s board realises that lifting total shareholder returns is its main duty. Early this year, Woodside decided to pare back its capital expenditure program and lift its dividend to shareholders. Pleasingly, this resulted in an immediate lift in the share price.

My guess is that the boards of both BHP and RIO will have noted the success of Woodside’s decision, and will soon move to shift some of their considerable excess cash (and franking credits) to their local shareholders.

FY14 Est. Dividend Yields:

BHP Billiton

3.8%

Rio Tinto

3.4%

Coca-Cola Amatil – I have this stock under review at the moment. Despite reporting an underwhelming profit result a few days ago, the company lifted its dividend slightly in the hope that the sharemarket would reward it for doing so. No such luck. While I still hold CCL in my portfolio, its reduced weighting reflects the fact it now must back up its cash dividend by a corresponding rise in earnings.

FY14 Est. Dividend Yield:

Coca-Cola Amatil

5.2%

Infrastructure Stocks – Although not all of these are able to add franking credits to their often handsome cash yields, the consistency of their payouts argues for their inclusion in my portfolio. My current top picks are Transurban and Sydney Airport (SYD). Both of these manage high-quality near monopoly assets, from which they are adept at extracting fees for shareholders. Unless people stop travelling by road and air, then Transurban and SYD should continue to lift their annual payouts for years to come.

FY14 Est. Dividend Yields:

Sydney Airports Corporation

6.4%

Transurban

5.0%

Supermarkets – Both Woolworths and Wesfarmers (i.e. Coles) are worthy of inclusion here. Although they trade on relatively high price-earnings ratios, they have huge market shares, operate in a duopoly that is only semi competitive at best, and sell products that most Australians have no choice but to buy on a weekly basis. Of the two, Wesfarmers has arguably the superior growth profile as its Coles supermarkets have more improvement to undergo. Having said this, Wesfarmers’ commitment to growing its fully franked dividend payments makes both companies core holdings in any yield-focused portfolio.

FY14 Est. Dividend Yields:

Wesfarmers

5,5%

Woolworths

4.2%

Conclusion

While interest rates remain low, equity markets are the place investors should look for yield. And although stocks outside the S&P ASX100 index can often provide alluringly high ratios of dividends to share prices, it’s always best to stick to the large, liquid and best researched stocks in Australia.

Finally, while investors should be a little perturbed at the impact Tony Abbott’s Paid Parental Leave Levy will have on franking credits (i.e. reduce them from 30% to 28.5%), in the longer term there isn’t so much to worry about. Although the largest 3,200 companies who’ll have to pay the levy will grumble and groan, Mr Abbott has promised it’ll be temporary. And we’d have no reason to mistrust a politician’s promise, would we?

To read more on the impact of the proposed changes to dividend franking credits, read Smaller companies biggest winners.


Tom Elliott, a director of Beulah Capital and a co-manager of the equity yield fund. The fund benchmarks against the ASX 100 Industrial Index and has outperformed the index by 2.7% - 27.82% against 25.08% - since its inception on March 9 2012