Divided by dividends

Who’s being looked after – shareholders or senior executives? A close look at the numbers hails BHP Billiton, CommBank, Westpac and Woolworths and slams Fairfax, Boral and major insurers.

PORTFOLIO POINT: BHP Billiton, CommBank are among those that have been taking care of their shareholders over the past seven years, unlike Fairfax and Boral.

As the curtains come down on the debt binge of the past 15 years, there are now serious questions and tests being put to our political and our business leaders. Their responses will set the scene for economic environment in 2012-13. The answers will stimulate or stymie markets and they will affect or support individual businesses.

Right now it feels like Europe is driving the world into some sort of economic quagmire. This leads to a growing perception that things aren’t sustainable. However, many governments are broke and fiscally cannot deliver change. Those that can (ie, Australia) seem dominated by individuals who are more concerned with maintaining power than doing anything with it.

The difficult world economic environment is creating a real test for our business leaders and their current responses are somewhat disheartening. We are seeing businesses beginning to address costs in response to clear signs of slowing economic and credit growth. The initial response of the leaders of banks, financiers and retailers is to retrench labour.

From an owner’s perspective, this may be justified as it supposedly holds profits. However, if service industries en masse decide to cut employment then, what will be the economic result? Will profits really be sustained with lower employment and thus consumption? What do our political leaders have to say about these developments? What is their plan? Is there a better alternative?

A cursory review of published and internet editorials of recent weeks, as these events unfold, shows a glaring gap in both the business response and the political review. The gap is obvious and uncomfortable for our business leaders. In our view, the reduction of business costs must begin at the top of a business.

Simply, the CEOs and boards of businesses, who now perceive that economic difficulty requires a cost adjustment, must start with their own costs. Indeed, many of the costs that reside at the top of major companies are the legacy of the debt era. It was a time where mediocre managers looked brilliant. However, it was due to the debt environment rather than their skill base.

By setting an example at the top then maybe the whole of an organisation and the community may follow. We question why this has this not even been contemplated and why our politicians have not focused on this. Is it not a widely held community view that executive salaries are wildly excessive? Is it not abundantly obvious that many businesses that grew with the credit binge from 1995 to 2005 have simply faltered in the past seven years?

Worse still, the shareholders (which are in the main large public super funds) of many listed and large companies have seen their capital diminish even as business leaders meticulously achieved continuous pay increases. Too often these increases seem to have been based on a perceived right rather than an achieved outcome.

Let us explore this further by doing a simple analysis of major companies today and in 2005. What dividends were paid in calendar 2011 and how does this compare to 2005? This may give us an insight into which companies have suspect business models. It may also identify those companies in which executives have been well rewarded for producing mediocre or poor returns. Finally, it may confirm our thoughts that good businesses will over time produce increasing returns to their owners.

Why the comparison to 2005? Well the sharemarket today is trading at the same price index level as 2005. Thus, index investors have achieved no capital gains in this period and have totally relied on their returns to have been derived from dividends.'¨

We have split our reviewed companies into the Good, the Average and the Bad.

The Good

BHP Billiton’s dividend in 2005 was 36.3¢ fully franked (ff) and last year it paid 98¢ (ff). BHP has not undertaken a dividend reinvestment plan (DRP) and it has had two significant buybacks. That is clearly a good outcome and the current outlook is positive. It remains a fundamental part of a value portfolio.

CommBank paid $1.97 (ff) in 2005 and lifted this to $3.20 in 2011. A DRP was utilised in 2005 and shareholders reinvested at $36. That is a good growing return but the outlook is now for lower growth for the next year. It is a company that is worth owning but the entry point for buyers should be yield focused at, say, 7% franked.

Westpac paid $1 (ff) in 2005 and this grew to $1.56 in 2011. That is similar dividend growth to CommBank and we suspect it would have been much faster had Westpac not acquired St George Bank in 2008. A DRP at $22 in 2005 has produced no capital gain for those participating shareholders. The outlook is for low growth in the coming year. Again a buy price at a yield of 7% franked seems appropriate.

Woolworths paid 51¢ in 2005 (ff) and has lifted this to $1.22 in 2011. That is very impressive for a supposedly low-growth company! Woolworths had a DRP in 2005 at $15.70 and that has rewarded participating shareholders. Since then it has undertaken buybacks and sailed through the GFC. The outlook is for more steady growth. Definitely a core portfolio holding managed by superior executives.

Oroton is a great recovery story from 2004. In 2005 the dividend was 12.5¢ (ff) and in 2011 it was 50¢. Oroton has not raised capital in the intervening period, has had no need for a DRP and shareholders have a received a steady flow of growing income. With Asia rolling out the outlook looks good.

McMillan Shakespeare is another company that has steadily raised dividends with no capital raisings until the recent employee option exercise. In 2005, it paid a dividend of 4¢ (ff) and in 2011 this grew to 50¢: a tremendous rate of compounding cash flow to shareholders! We expect more growth in 2012 and this is one company whose executives have deserved their rewards.

The Average

ANZ Banking Group rates behind the other majors (above) based on dividend growth. In 2005 $1.10 (ff) was paid and lifted to $1.40 in 2011. A DRP at $22.50 in 2005 has been followed by successive raisings. ANZ now has a growth profile in Asia, which will need to be successful to compensate long-term shareholders for a mediocre return.

David Jones is now in a quandary after a successful business recovery in the past 10 years. Dividends paid in 2005 were 13¢ (ff) and these lifted to 28¢ in 2011. That's impressive but the recent downgrade and the impact of the internet suggests that dividends are about to decline from here.

National Australia Bank paid $1.66 in 2005 and grew this to just $1.72 in 2011. In 2005 NAB issued DRP shares at $32 and those who took that reinvestment opportunity have been treated poorly. Here is the worst of the big four on any measure, and shareholders should rightly question the growth of remuneration packages for its senior executives.

QBE Insurance paid 63¢ (partly franked) in 2005 and grew these to $1.28 last year. However, a rapid expansion to the US and successive capital raisings have seen return on equity tumble and dividends become unfranked. The recent downgrade will see dividends reduced and more offshore acquisitions await shareholders. A DRP of $14.80 in 2005 is now below water. QBE is the best of a bad bunch of insurance investments but, do we really need to own any of them?

Telstra actually paid 40¢ (ff) to shareholders in 2005. This was the contrived special payout that allowed the government to divest more shares through T3. Since then dividends have been rock solid at 28¢. The recent share price recovery is only partly recouping the falls of the previous six years. But positively there has been no capital raised and a steady cash flow to shareholders. The outlook is reasonable should the NBN ever be sanctioned by the ACCC. Telstra is now managed by executives who are paid substantially less than the American “dream team” whose main focus was on selling the government's shares.

The Bad

Fairfax Media has been a disaster for shareholders and the outlook remains poor. Dividends have declined from 23.5¢ (ff) in 2005 to just 3¢ last year. Do you remember the $4.59 DRP in 2005? The current outlook does not look any better.

Boral has managed to deliver declining dividends as well as a declining share price. Dividends were 34¢ (ff) in 2005 and just 14.5¢ last year. The $8.60 DRP of 2005 must send shudders down the spine of the poor souls who took it up!

IAG (the former NRMA) is a telling example of why a successful and community focused mutual should never have become a public company. In 2005 a DRP at $5.40 was undertaken to support dividends of 26.5¢ (ff). Last year dividends continued their decline to just 16¢. Insurance companies remain great places for employees but owner returns are less predictable.

Suncorp-Metway has been a shocker for shareholders. This banc-assurance company has never delivered the much-touted promises supporting a succession of acquisitions. In 2005 it paid a dividend of $1.47 (ff) supported by a DRP at $19.40. Last year the dividend fell to just 35¢ and investors must surely question why any insurance company should be regarded as a sensible long-term investment.

Macquarie Group has always been lucrative for executives but now is a poor investment for long-term shareholders. In the boom times of 2005, a dividend of $2.30 (90% franked) was paid and shareholders were invited to reinvest their dividend at $60. In 2011 the unfranked dividend dropped to $1.65. This followed massive capital raisings in recent years and a rapidly declining return on equity.

Qantas has taken its dividend rate down from 19¢ (ff) in 2005 to nothing over the past two years. Meanwhile, the executives have negotiated higher salaries and have been seen to be buyers of their shares despite their desired MBO in 2005! The message is simple for investors: look elsewhere.

Wesfarmers’ dividend has fallen from $1.45 (ff) in 2005 to $1.35 (ff) in 2010-11, a 6.9% decline. This is despite a tripling in net operating cash flows and the businesses equity base now being nine times larger. Net return on equity is a third of 2005 levels as a result of the large capital raising to acquire Coles in 2007. However, the performance package paid to the managing director (Richard Goyder stepped up in the second half of 2005) is now worth twice as much as it was in 2005. Again it seems that management remuneration is not adequately tied to shareholder returns.


The above shows that business performance and thus shareholder returns are wildly inconsistent across the market. The growing levels of executive salaries seems unrelated to business performance as some executives of BAD performers get paid consistently more (relative to market capitalisation) then those at GOOD performers.

Further, investors must and are sensibly becoming more focused on dividend growth as a major means of achieving satisfactory returns from the sharemarket. Thus, executives and boards must be clearly given the message that steady business growth is preferable to growth by acquisitions or the reinvestment of capital into businesses at sub optimal returns on equity.

I believe that the folly of short-term remuneration packages based on total shareholder or relative shareholder returns has been exposed as another means by which wealth is transferred from the many to a few.

Shareholder returns are clearly important but:

  • They can only be assessed on a long-term basis of at least five years and probably more likely over 10 years.
  • Relative returns against an index or peer group should be junked. The proxy of outperforming a poor performing peer group is a receipt for mediocrity and the world has way too much of that at present.

John Abernethy is CEO of Clime Investment Management. Clime’s online stock valuation and research service, MyClime, can assist investors seeking to identify companies that act in the interests of their shareholders. To register for a free two-week trial, click here.

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