Investors devour hybrids for yield

With markets going backwards in the past 12 months, this national obsession with high yields has created an opening for investment banks and brokers to advise companies to issue high-yielding hybrid securities.

In the past year, companies have paid out almost $60 billion in dividends the payout ratio has risen to 67 per cent and they have issued more than $8 billion of hybrid securities as they have seen the merits of a financial instrument that gives them a capital injection but doesn't jeopardise their credit rating or dilute equity.

Issues of hybrid securities are expected to rise in the next few months as investors continue to favour high-yielding products. In the past two weeks, three offers have hit the market from Caltex, APA Group and Crown totalling more than $1.5 billion. Commonwealth Bank is rumoured to be looking at launching a hybrid issue to refinance its $1.4 billion Perls IV tier-one hybrid offer. AMP is also believed to be considering a hybrid issue to boost its capital, as are several other companies.

These hybrid securities are pitched at retail investors as a high-yielding return at a time when the interest rates for term deposits have fallen from up to 7 per cent six months ago to 5 per cent or less, and cash management trusts are offering even less. If the Reserve Bank continues to cut official interest rates, term deposits will fall even further.

To put it into context, most hybrids are offering returns of more than 350 basis points over the bank bill rate. With a surge in self-managed super funds, the appetite for these products, which are being pitched as safe, will only increase. They are listed on the ASX and are therefore relatively liquid, and at the end of a set period, investors get repaid in full or such is their expectation.

In the case of listed property outfit Goodman Group, it confirmed last week that it was looking to replace its $325 million hybrid, which was scheduled to be repaid in full this coming March. Instead of paying it out, Goodman has decided to do a new one. What is interesting is the new rate being offered is higher than the current one but less than what is being offered by casino operator Crown and APA, which is a gas utility operator. If investors don't like it they can sell the securities on the ASX it is currently trading at 89? although some would have hoped to get 100? in the dollar in seven months' time.

If the company issuing the hybrid is doing well, then the investor has nothing to worry about. However, in most cases, these securities are unsecured and so, in a wind-up scenario, investors could lose all their capital, which isn't much different from equity holders. In addition, a hybrid security's value is more aligned to a company's stock as a company's ability to generate revenue to meet its obligations influences the probability that hybrid distributions will be met and capital returned.

But it isn't just hybrids that are doing well among investors. Companies offering high payouts and high dividend yields have also done relatively better than growth stocks in the past year. Telstra, the banks, supermarkets and listed property trusts have all outperformed the overall market. To ensure this continues, some companies during profit season have been placing a strong emphasis on dividend growth in their outlook statements. GPT and Dexus, for example, have done this, while Telstra has committed to paying fully franked dividends of 14? a share every six months for the next 18 months. The companies that disappointed on the dividend front were punished accordingly. One of the most notable was Tabcorp, which declared a final dividend of 11? a share fully franked, down from 19? a share a year earlier. Its shares have dived more than 10 per cent.

The market is split on whether the rush for safety and dividends has got to a point where the stocks are now overvalued and should be dumped to take profits, or whether the global uncertainty and low bank deposit rates will give high-yielding stocks another leg-up. Credit Suisse has just issued a report that recommends investors focus on high-dividend yield stocks and quality Australian stocks, and highlights National Australia Bank, Rio Tinto and Newcrest Mining.

The consensus estimate is that earnings per share (EPS) actually shrank in 2012. The market will be seeking confidence from company outlook statements to underwrite the outlook for the S&P/ASX 200 Index. At the end of 2011, The Institutional Brokers Estimates System consensus for S&P/ASX 200 Index stocks was for EPS growth in the high single digits for this financial year. After some big EPS downgrades, particularly in resources, the expectation is now for a fall of up to 5 per cent.

Despite the interest in hybrid securities and stocks with high dividend yields, volumes on the ASX are still weak, making it hard for stockbrokers to turn a dollar. It is also having an impact on fund managers, with Constellation Capital announcing last week that it had closed its funds management division. If new regulations as part of the Future of Financial Advice reforms go ahead in relation to the non-broker broker world, there will be a shake-out there too.

aferguson@fairfaxmedia.com.au