Our Income First model portfolio does the business

The portfolio has seen a swell in news flow but its yield and total return are within our expectations.

Summary: The Income First model portfolio is well diversified and performing well as a whole despite poor performance from DSH. ANZ and NAB still offer an attractive dividend but the portfolio’s underweight exposure to banks is not likely to be increased. AGM season continues and these meetings can help update investors on how companies are tracking.

Key take-out: The invested portion of the Income First model portfolio is beating the All Ordinaries on a price basis. The portfolio’s total returns and yield are within our expectations.

Key beneficiaries: General investors. Category: Income.

Over the past few weeks, the Income First model portfolio has seen a swell in market sensitive news flow and individual stock volatility. This is to be expected during late October as the banks reported financial results, quarterly trading updates are provided from many businesses (such as TTS and DSH) and plenty of companies that have a June 30 financial year end hold their annual general meetings. There has also been some acquisition activity and contract announcements (FXL and TTS respectively).

There is no shortage of action in the portfolio and I think it important that investors stay closely informed as to the news and performances of the companies in the portfolio. With this in mind, let’s explore the portfolio implications of recent news and announcements, and the accompanying share prices as they apply to the overall portfolio.

ANZ and NAB seeing the pressure applied

Both ANZ and NAB reported record profits recently. Of course, both also have recently lifted variable lending rates to cope with increased regulatory pressure as well. In my view this is a sign that the pressures we suspected were building on the banks are beginning to manifest in a more meaningful way.

Despite this, the dividends from both ANZ and NAB were in line with our expectations at 95c and 99c respectively. Both are now trading on an ex-dividend basis, so I am pleased to have brought additional yield and franking credits into the portfolio.

It should be noted that the banks have underperformed the market of late, and that we expect this will continue. The portfolio’s heavily underweight exposure to banks is not likely to be increased. If anything, the banks will be reviewed again at the next quarterly update in February to assess their value in the portfolio. For now, I am comfortable that the banks still offer a base dividend yield that is too attractive to pass up, albeit at a low level of exposure and in the context of a well-diversified portfolio.

Annual general meetings at TTS and DSH

It’s AGM season for companies that have a June 30 year end. I believe that AGMs and the presentations provided have become more and more important in recent years. The increasing focus on management remuneration and its link to performance and shareholder returns has been improving, but there is much more work to do.

Tatts Group Limited (TTS), a recent addition to the portfolio, provided an update to Q1 trading at its AGM, highlighting that slow growth was being achieved. The lotteries division is tracking ahead of last year as a result of increased jackpot numbers and the “set for life” product introduction. Effectively, it’s steady as she goes at TTS.

DSH was different and we have written on this extensively (see Dick Smith disappoints, October 28 and Kohler’s Week, November 7). The company provided a stable quarterly trading update, but downgraded profit guidance for the full year after a dismal sales performance in October. This is concerning, but after conducting our analysis and due diligence, we are comfortable holding on to DSH in the portfolio at the current exposure levels.

An important note on portfolio attribution and diversification

I have answered quite a few letters in recent weeks regarding the tumble in the share price of DSH. There is definitely value in the examination of how and why the share price has fared so poorly, and how the outlook now stands for the company (please view my piece on DSH from October 28 here). However, it is important to consider the implications of a 60 per cent share price decline from a portfolio perspective to understand if the approach to diversification has to date been sufficient to mitigate such violent potential stock specific risks.

The good news is that the portfolio is well diversified and performing well as a whole, in the face of the poor performance from DSH. Here is the portfolio make up in percentage terms by stock:

As can be seen the biggest holding is still cash. This will be invested over time but there is no rush at present given that the portfolio is forecast to yield close to 5.5 per cent (including full franking benefits) based on the current 63 per cent invested level. This gives me confidence that the income targets for the portfolio will be well and truly met, with the potential for us to continue to hold some cash and keep volatility in the overall portfolio in check.

And this is evident through the model’s performance to date. Below is a table showing the returns by stock and dividends accrued for each stock since the model’s inception on August 11. While the model is down overall by around 1.5 per cent, the S&P/ASX All Ordinaries Index is down by around 4 per cent over the same period.

Code

Price in

Units

Dollars Invested

Dividends received

Price (Nov 6)

Return

AHG

4.40

1591

7000.40

206.83

$4.19

-1.82%

ANZ

30.80

195

6006.00

0

$25.835

-13.04%

ARF

1.61

3106

5000.66

0

$1.75

8.70%

DSH

1.89

4685

8854.65

234.25

$0.825

-53.70%

DWS

1.01

4950

4999.50

0

$1.20

18.81%

FXL

2.58

2326

6001.08

209.34

$3.04

21.32%

GEM

3.16

1266

4000.56

75.96

$3.34

7.59%

NAB

33.36

180

6004.80

178.2

$28.78

-10.76%

TTS

3.99

1504

6000.96

0

$3.90

-2.26%

VRT

5.20

962

5002.40

134.68

$6.34

24.62%

WLL

4.10

1220

5002.00

146.4

$4.62

15.61%

Future AGM dates and expected updates

As the end of the calendar year nears, it is important for us to be vigilant in understanding the important potential share price catalysts for all the companies currently in the portfolio, both upside catalysts and potential risk events.

Here is a table of the meaningful events we are anticipating from the Income First portfolio held stocks between now and early 2016. DWS Limited will hold its AGM tomorrow (Tuesday November 10), with a few more AGMs to come in the following weeks. These meetings have the potential to provide investors with an update as to how the companies are tracking, so we will be keenly watching for any hints as to performance.

Company

Date

Event

DWS Limited

10/11/2015

AGM

Arena REIT

19/11/2015

AGM

Automotive Holdings

20/11/2015

AGM

Flexigroup Limited

23/11/2015

AGM

G8 Education

Late November 2015

Dividend declaration

National Bank

17/12/2015

AGM

ANZ Bank

17/12/2015

AGM

Dick Smith

Feb-16

Financial report

Wellcom Group

Feb-16

Financial report

Virtus Health

Feb-16

Financial report

Tatts Group Limited

Feb-16

Financial report

Summary

To date the Income First model portfolio is tracking to our expectations, with the invested portion of the portfolio outperforming the All Ordinaries on a price basis. Additionally, the total returns of the portfolio and the yield being accrued to date are within our expectations.

The end result is being achieved, although it is being achieved through a slightly different performance mix than was expected: DSH has underperformed, while VRT, FXL, WLL and DWS have surpassed expectations. Nonetheless, the important thing is that the portfolio is tracking to achieve all of its objectives, despite a volatile market, and is overall producing some outperformance compared to the S&P ASX All Ordinaries.

We will continue to look to add to the portfolio, but again note that we are comfortable holding some cash for the minute, especially given the strong forecast yield of the businesses we have invested in to date.

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