Cashing up while the franking hay still shines

The cash balances of many investors and self-managed funds are set to be enriched, firstly by Rio Tinto's big payouts and then a similar set of major returns from BHP as a result of the sale of the US shale and gas operations.

In both cases the companies are going to use up a significant slab of their stored franking credits and I suspect other companies that have similar accumulated franking credits on their balance sheet will also consider returns if they have the cash availability.

The agenda that few directors mention is that there is a very good chance that the ALP will be the next government and they plan a vicious attack on Australian retiree battlers who are attempting to self fund their retirement. The attack is being made in the name of ripping money off so called “rich retirees”. But that is simply false.

The measures will hardly take a cent from “rich retirees”, but it will affect those with assets of roughly between $800,000 and $1.6 million who are battling to fund their own retirement. I believe there is a good chance that products will emerge between now and the election which will help battling retirees retain their franking credits, but that is in the future.

Companies are starting to appreciate that they have a large number of shareholders who are in danger of being selectively victimised by an ALP government and I think many are going to help.

The other aspect of these big capital/dividend returns is that Australian companies have lost a lot of the growth momentum that existed in decades gone by.

And the shareholders who are aged in their 50s and above are looking for income. When a company suddenly emerges with growth ideas that require capital it can affect the value of shares.

Transurban's detour impact

Here I want to share with you a personal experience. Many years ago I had long discussions with the Canadian pensions people, who explained that toll roads were a wonderful retirement asset because their income was linked to inflation, and historically toll roads were not greatly affected by economic downturns.

I made an investment in a toll road group called ConnectEast, and very sadly and ironically was forced to sell because of a Canadian takeover at what I knew was a very low price.

So I switched to the only other alternative in Australia – Transurban – and until recently it has been a wonderful ride. But Transurban has got the growth bug and so it made an issue late last year at $11.40 a share to fund the western tunnel project. It was actually a good exercise, because the project was moderate and increased the life of the base Citylink toll way.

But then Transurban was tantalised by the prospect of bidding for the giant Sydney toll complex called WestConnex. There is no doubt that Transurban paid a very full price for a controlling stake in that asset, and indeed many think it overpaid.

But it was caught, because if Transurban's offer price was not well above its opponent it would have lost, given the complexities of the ACCC viewpoint. Transurban says that, viewed over a decade, WestConnext will increase returns. But there is absolutely no doubt that in the next, say, three years dividend returns will be reduced because a large amount of equity is being raised and WestConnext is not a big contributor to the bottom line in the next three years.

Transurban was set to substantially increase payments but will now be much more restrained because there is greater capital to service.

At the same time US interest rates are rising, with the US 10-year bond rate having broken through 3 per cent, and it will rise further. This lessens the attraction of income stocks like Transurban.

Looking at broker research, including the odd pieces of research from brokers who are linked to the underwriting, it looks to me that that deal has taken about $1 a share from the immediate value of Transurban. Retail investors with entitlements to the recent issue at $10.80 a share (lower than the previous issue price), totalling almost $400 million, turned their back on the issue. The shares were placed with institutions and/or underwriters immediately.

I have no doubt that in the long term WestConnext will add to value, despite the short-term loss. And so current shareholders must suffer in the hope of a longer-term benefit. That is typical of a growth situation, although in decades gone by the growth potential would have attracted a greater premium. I took up my entitlement, because the issue price took into account the $1 a share loss in immediate value and yields 5.5 per cent. I am happy with the growth prospect, but would have been even happier with a higher income in the next two or three years.

This corporate nervousness about growth is not confined to Australia.

Tax cuts and capital returns

When Donald Trump cut US corporate taxes he said it would greatly increase American investment, and our Prime Minister copied the US president as he advocated lower Australian corporate taxes for large enterprises.

Trump might be right, but there has been a vast increase in the amount of capital returns and higher dividend payments. It looks like capital returns have doubled in the US since the tax cut. Along with the strong US economy, that's sending US markets again into record territory.

But the large US capital returns are rather embarrassing for the Coalition government in Australia. The politicians think that lower taxes will boost investment, but in fact the demand for income by large shareholders and the nervousness of corporate boards is holding back investment irrespective of tax rates.

The truth is that we are engaged in enormous technology change and somewhere down the line corporate boards and their shareholders need to start thinking differently about their level of investment.

Despite the rise in capital returns in America, the understanding by US corporate boards of the need to invest to stay up to date is better than Australia. But maybe we are headed into an era where shareholders' demand for income will make new investment that much less attractive.

I believe Australia would be much better served to have generous capital investment write-offs than going down the corporate tax cut route. But it is possible that even this would not work because of this new culture that is permeating both Australian and American companies.

But then, of course, we have the great example of Amazon, which doesn't pay dividends and reinvest all its profits, so creating a huge growth vehicle. But even in the case of Amazon its shares have been discounted in recent times, so it might not always be able to embrace that strategy.