There is an old adage that when markets are falling, investors salt their money away in the bank or invest in stocks that offer high yields and, when markets go up, they switch to the riskier growth stocks. 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 more than $8 billion in the issue of hybrid securities, as companies see the merits of a financial instrument that gives them a capital injection but doesn't jeopardise their credit rating or dilute their equity.
Hybrid securities are expected to ramp up 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 to a total of more than $1.5 billion. The 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, along with several other companies.
These hybrid securities are pitched at retail investors as a high yielding return at a time when the safe haven of term deposit rates 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 so they believe.
In the case of listed property group 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, they have 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 trading at 89? - but some would have hoped to get 100? in the dollar in seven months.
If the company issuing the hybrid is doing well, then the investor has nothing to worry about. But 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 its 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. This includes GPT and Dexus, 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 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 now estimates that earnings per share (EPS) growth was negative in 2012. The market will be seeking confidence from company outlook statements to underwrite the outlook for the ASX 200. At the end of 2011, The Institutional Brokers Estimates System (IBES) consensus for the ASX 200 was for EPS growth in the high single digits for this financial year. After some significant EPS downgrades, particularly for the resources sector, the expectation is now for a fall in earnings 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 has closed its funds management division as the industry faces consolidation.
If new regulations as part of the Future of Financial Advice (FOFA) reforms go ahead in relation to the non-broker world, there will be a shake-out there too.
Frequently Asked Questions about this Article…
What are hybrid securities and why are they becoming popular with investors?
Hybrid securities are instruments companies issue that mix features of debt and equity. According to the article, they're popular because they offer higher yields to retail investors, give companies a capital injection without diluting equity or hurting credit ratings, and have seen about $8 billion issued in the past year as investors chase income.
How do hybrid returns compare with term deposits and the bank bill rate?
The article notes hybrids are offering materially higher returns — typically more than 350 basis points over the bank bill rate. Term deposit rates have fallen from around 7% six months ago to about 5% or less, making hybrids relatively attractive to yield-seeking investors.
Are hybrid securities safe — what are the key risks I should know?
Hybrids can be risky. The article warns many are unsecured, so in a company wind-up investors could lose all their capital (similar to equity holders). Hybrid distributions and capital repayment depend on the issuer's revenue and financial health, so the value is closely tied to the company's performance.
Can I sell listed hybrids on the ASX if I need to exit my position?
Yes — the article says many hybrids are listed on the ASX and therefore relatively liquid, so investors can sell them. It gives the example of Goodman Group’s hybrid trading below par (around 89), underscoring that market price may differ from the hoped-for repayment at 100 in future months.
Which companies have recently issued or are considering hybrid offers?
Recent offers mentioned in the article include Caltex, APA Group and Crown (totaling more than $1.5 billion in the past two weeks). The Commonwealth Bank was rumoured to be looking at a hybrid to refinance its PERLS IV issue, AMP was believed to be considering a hybrid to boost capital, and Goodman Group planned to replace a $325 million hybrid.
How have high-dividend and payout-focused stocks performed compared with growth stocks?
The article reports that high-payout companies — Telstra, the banks, supermarkets and listed property trusts — have generally outperformed growth stocks over the past year. Some companies have emphasised dividend growth in outlook statements, with GPT and Dexus highlighted and Telstra committing to fully franked dividends every six months for the next 18 months.
What happens to companies and shares when dividend payouts are cut?
When companies disappoint on dividends they can be punished by the market. The article cites Tabcorp as an example: its final dividend was cut (from a higher level the year before) and its shares fell more than 10% after the announcement.
What is the market outlook for earnings, and how might this affect brokers and fund managers?
The article says consensus estimates point to negative EPS growth in 2012 and that expectations have moved to a possible fall in earnings of up to about 5%. It also notes weak ASX volumes are making it hard for stockbrokers to turn a dollar and have led at least one firm (Constellation Capital) to close its funds management division. The market is split on whether the rush to high yields has overvalued stocks or will continue to support them amid low bank deposit rates; Credit Suisse recommended focusing on high dividend yield and quality Australian stocks such as National Australia Bank, Rio Tinto and Newcrest Mining.
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