Mining the hunt for yield

A string of results from mining and mining services majors in recent weeks have suddenly confirmed a powerful trend within the ASX. Resource-related stocks, traditionally ‘growth’ stocks where the dividend mattered little, have moved to satisfy the deep appetite among investors for income … and it’s working!

Certainly that’s the initial outcome from a strategic push among many of our better-known resource related companies, which have timed their moves well as it coincides with much-anticipated ‘dividend compression’ among bank stocks.

Just take a look at the table below to see the effect: Commonwealth Bank, the kingpin of the local banking sector, has a dividend that’s shrinking. Meanwhile, companies as diverse as Aurizon and Orica are building their dividend payouts. As you can see, CBA’s yield a year ago was nearly 6%. Today its one-year forecast yield is barely 5%. In contrast, Woodside Petroleum is in the process of doubling its yield from 3.4% to 6.5% – a level well in excess of CBA. What is happening, and what does it mean for investors ?

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Once a game confined to the banks, which appear to have been squeezed dry, the yield-hunt rules changed when Woodside mothballed its hugely expensive ($40 billion) Browse LNG project and said it would boost its return to shareholders.

The effect of the Woodside switch was immediate, with yield-hunting investors, especially self-managed superannuation funds in or nearing the zero-tax pension phase, rushing to acquire Woodside shares despite oil stocks traditionally being seen as far too risky for retirement savings.

From $34 before the special dividend and promised big lift in the future payout ratio was announced, Woodside rose to $37 and, more importantly, has continued to rise despite a flat-to-falling oil price over much of 2013.

Last week, as the price of Brent-quality crude oil dipped to $US107 a barrel and West Texas Intermediate retreated to less than $US94/bbl, Woodside’s shares hit a 12-month high of $39.53.

Flat-to-falling oil prices and a rising oil-company share price do not make sense unless there is another force at work, and that’s a combination of institutional investors and self-managed superannuation funds preferring yield today rather than the promise (but not the guarantee) of growth tomorrow.

At Woodside, an investor acquiring shares today can expect a dividend yield (assuming no more special payments) of 4%, a number which expands when the shares are held in a low-tax superannuation fund, and which is almost bank-like in terms of return on investment.

For investors who prefer their oil companies to be growth focussed, developing a pipeline of new projects, Woodside has lost much of its appeal. For yield-hunters it’s almost an essential addition to a portfolio.

Aurizon, a resource-exposed company that is not a direct investor in resources, has emerged from its status as a former agency of the Queensland Government to become an attractive high-yield stock.

Essentially, Aurizon has morphed into a coal-transport annuity, with an iron ore growth option. An investment today yields around 3.4%, but is expected to rise over the next two years to around 4.4% as it cranks up coal haulage fees, a process which is angering coal-mining companies.

As the operator of four coal-hauling systems which trade under the banner of the Central Queensland Coal Network, Aurizon has near-monopoly powers when it comes to getting coal from inland mines to port.

Last month Aurizon flexed its haulage muscles by filing an updated “undertaking” with competition authorities. This featured a 36% price hike on a dollar-per-tonne basis compared with the current, but three-year-old, price structure.

The mining companies, naturally, cried foul with their lobby group, the Queensland Resources Council (QRC), saying that the rail transport increase would add $1.2 billion to the operating costs of coal miners over the four years from 2013-14

One man’s cost is another man’s profit, because in the days after the QRC delivered that complaint Aurizon’s share price added a few cents, rising from $4.65 to an all-time high of $4.82 on October 31, and remains close to that level with last trades at around $4.77.

Analysts like the exposure to the increasing volumes of coal but see Aurizon’s shares near their peak, with neutral the dominant investment recommendation.

But that advice from investment banks such as Macquarie, CIMB and UBS misses the appeal of Aurizon to yield hunters, because the company has just boosted its final dividend from 4.6c to 8.2c and directors have proposed lifting the annual payout ratio from around 50% of profit to between 60% and 70%.

J.P. Morgan, Macquarie and CIMB are tipping a dividend this year of 16c a share. Credit Suisse adds a fraction more, forecasting a payout of 16.13c – with most analysts seeing a payout of around 20c in 2015.

Orica, a big manufacturer of industrial explosives and chemicals, started playing the yield game on Monday when it reported a lacklustre (but better than forecast) 4% fall in pre-tax profit for the year to September 30, and a surprise 2% increase in the final dividend, with the potential for higher dividends and some form of capital management (perhaps a share buy-back) next year.

The effect of increased payouts, and prospects of more to come, electrified Orica’s share price, which has risen by 19% since the company announced a lower pre-tax profit.

Interestingly, analysts from some of the international investment banks, such as Citi, J.P. Morgan and UBS, were impressed with the possibility of Orica earning higher profits in the current year, but restricted their recommendations to neutral.

Macquarie, one of the leading Australian investment banks (perhaps with a greater understanding of the appetite for yield stocks in the self-managed superannuation sector), upgraded its recommendation to outperform, noting that Orica’s low-gearing “provides potential for capital management going forward given an expected capital expenditure reduction in the 2014 financial year”.

Incitec Pivot enjoyed an even more interesting reaction from investors after reporting on Tuesday a poor result for the year to September 30, with sales down 3%, pre-tax profit down 22%, full year’s dividend down 26% – all of which led to a surprise 7% share-price increase.

Some of this week’s heavy buying of Incitec Pivot shares will have been conventional investing on the promise of better trading in the current financial year, though the bulk of investment banks rate the stock as neutral (Macquarie, Citi, J.P. Morgan and Credit Suisse) with a consensus share price over the next 12-months of $2.98, marginally above the current $2.80.

It’s when you look below the profit and share price forecasts that another number jumps out, and that’s the prospective dividend increase from this year’s reduced 9.2c back to as high as 11.9c, according to Credit Suisse. It forecasts it will then rise to 16.1c in 2015, lifting the yield on Incitec Pivot from its current relatively attractive 3.3% to 4.2% in 2014, and 5.8% in 2015.

It’s also worth noting that the two biggest names in resources, BHP and Rio, have both been playing the same game in a more gradual manner. BHP’s dividend yield is forecast to inch ahead to 3.5%, while Rio moves up to 3%. Those improving yields may seem modest by today’ standards, but for long-term holders in the big miners it’s a deep trend which is likely to continue well into the future.

For self-managed superannuation funds, with the promise of a yield which is roughly double the interest being paid on bank deposits, and close to triple on an after-tax basis, it’s easy to see why the yield-hunting game remains alive and well, especially for funds entering the pension phase.

Company directors, keen to boost their share price, have recognised the game being played. More of them are adopting higher-than-traditional payout ratios to attract investors – while also looking good in the eyes of their shareholders.

Whether any of this is good for the long-term development of Australian industry is another question, because one way of looking at the move to higher payout ratios is that the baby-boomer generation is once again showing a tendency to “eat the future” of their children by taking money out of companies that might otherwise have been invested in job-creating capital works and spending it on a European holiday.

Yield-hunting is a tricky game, and not without its risks, but it is a game of increasing popularity as it spreads from banks to a wide variety of industrial, mining and (even) oil stocks.