Boston Consulting Group has blown the warning whistle on the Australian share market. We face a much deeper problem than the recent lower iron ore prices and the slowdown in global growth that hit Wall Street last night.
Boston Consulting’s latest annual Australian Value Creators Report, released today, shows Australia businesses paid out almost twice as much in dividends (as a percentage of earnings) as their global peers in the 2014 financial year. That’s an incredible difference. Not surprisingly, as they are not investing in their businesses, Australian CEOs are falling further behind the rest of the developed world in earnings per share growth.
Boston Consulting says that lifting dividend payout ratios has been an understandable response by management as Australian investors have become more risk averse since the GFC. This is especially true given the difficulty in finding value accretive growth opportunities.
While understandable, bloated payout ratios are a dangerous strategy and Boston’s Ramesh Karnani warns: “Climbing dividend payout ratios cannot be sustained for long and only postpone an inevitable crunch. The growth-versus-dividend debate in Australia has lost sight of the fact that growth is a prerequisite of sustainable dividend increases.” He is absolutely right.
The underperformance of Australia chief executives and boards on the earnings per share growth front -- because they are paying out too much in dividends -- is highlighted by the graphs below.
Of course Boston Consulting's warning to Australian investors has already been discovered by many global investors, making the Australian share market one of the worst performing in the developed world.
In my view, poor Australian corporate profit performance relative to the rest of the world is likely to continue for some years and may even get worse. Nothing will change until we get a new generation of chief executives who devise growth strategies that they can communicate to shareholders, particularly self-managed superannuation funds.
So how do we solve the problem given that many boards are too petrified to appoint a risk-taking chief executive?
What’s happening now is that our large corporations are engaged in a drive to lower costs and improve productivity, usually involving retrenching employees and freezing salaries. That’s not a bad thing, but with very few growth strategies around it will create a much tougher economic environment.
Boston Consulting says that business leaders cannot solve the growth crisis on their own.
“They must work more closely with investors to explain the importance of taking greater risks and investing in the medium- to long-term to build sustainable value."
That sounds like a good idea, but, Australia is not blessed with high standard investment analysts, which is one reason why payout ratios are too high. In my view, the chief executives have got to get out of their cocoons and begin talking to the self-managed funds who have woken up to the fact that high cost managers do not always perform.
Boston Consulting also argues that in Australia there is a “wrongly-perceived” view that acquisitions are destructive for shareholder wealth. The reverse is true and for Australian companies this is “an under-utilised growth option.”
Boston’s analysis of results over the past decade shows that highly acquisitive companies in the current ASX200 outperformed in value creation, with a median annual total shareholder return of 17 per cent, compared to 12 per cent for all ASX 200 over the past decade.
Two Australian companies that Boston point to as successful examples of this strategy are CSL and Ramsay.
But Boston says that those companies that embrace acquisitions to create growth must have rigorous discipline with a compelling investment thesis. They also need to implement the plan and fully realise the synergies.
This is not a skill that all CEOs have.