Three blue-chip dividends under threat

They announced higher dividends, but experts think these three companies won’t be able to repeat them.

Summary: Investors are loving some of the high dividend yields on offer right now, and outside of the major banks and Telstra there are plenty of opportunities. But it seems some of the companies that have lifted their dividends in the latest profit season may not be able to sustain them, and investors should be careful in their hunt for yield.
Key take-out: Australian investors enjoyed dividend growth of 6%, but that’s twice the GDP growth rate. It’s unlikely some companies will be able to maintain their payout rates.
Key beneficiaries: General investors. Category: Shares.

In a low rate environment everyone is suddenly chasing dividends and ASX-listed companies are only too happy to oblige : The question now is ... are they too happy to please?

After a mixed results reporting season, the smoke is clearing and analysts are starting to take a second look at some of the key forecasts for the year ahead.

In the year to June 2013 Australian investors enjoyed dividend growth of 6%. What’s more, consensus forecasts are for dividend growth of 7.5% in 2013-14 for the S&P/ASX 200, while earnings per share growth estimates are set at 5.5%.

But some are worried the figures simply don't add up. If GDP forecasts are being peeled back to less than 2.5%, how on earth are our leading companies going to keep pushing up dividend payments at twice that pace?

“2014 earnings estimates up in the double-digits are probably still too high, and without predicting Armageddon those numbers probably need to come down,” says Graham Harman of Russell Investments.

"My biggest concern would be that there is going to be some nexus between the forecast profit growth we have and the forecast dividend growth," he explains.

Moreover, concerns are mounting that some companies will promise higher dividends, but not because the company operations are faring better. Rather, the promise is being made to lure dividend hungry investors ... a move that could easily come unstuck if earnings fail to materialise.

The Commonwealth Bank of Australia and Telstra, the leading dividend stocks on the Australian Securities Exchange, have already signalled they do not wish to be seen as stocks that continually lift dividends. Both left their dividend unchanged and offered no further guidance in their latest set of results.

But three leading companies that don’t quite have the same support base as CBA and Telstra – Insurance Australia Group (IAG), Coca-Cola Amatil (CCL) and Suncorp (SUN) – are now under the spotlight for offering mouth-watering dividends to shareholders they might not be able to replicate or improve in future periods.

Suncorp

Suncorp’s 32.1% fall in net profit to $491 million as it shed its troublesome non-core bank division took a back seat when it released its full-year results.

What took centre stage was the 50% lift in the final dividend to 30 cents a share and the 20 cents special dividend, both fully-franked, as well as Suncorp’s pledge to continue to return surplus capital in the periods ahead.

This created an excellent short-term trading opportunity for investors to capture high returns before the ex-dividend date on Monday, August 26th.

The market certainly thought so, with the company climbing 3.5% after the results last week before erasing those gains on Monday.

But consensus forecasts see Suncorp’s payout ratio increasing to 80% from 71% in 2013-14, right at the top of its guidance for between 60% and 80%.

For Equity Trustees chief investment officer, George Boubouras, a payout ratio that high touches unacceptable levels given its sector.

“You want consistent payout ratios for banks – between 55% and 65% is the sweet spot,” he says.

“Suncorp might be a good short-term income stream but it doesn’t create consistency down the line, which is unfortunate for retail investors who, through their self-managed super funds (SMSFs), very much appear to be searching for yield in that equity asset class regardless.”

Like Harman, Boubouras believes earnings estimates for Australian companies are too high on average for 2013-14. In his forecast models he is removing double-digit earnings per share growth and has set it at between 7% and 7.5% across the broader market.

Suncorp

2013-14

2014-15

Earnings/share

97.5c

$1.09

Dividend/share

78.2c

81.1c

EPS growth

151.4%

11.4%

DPS growth

42.2%

3.8%

Price/Earnings

12.7 times

11.4 times

Dividend Yield

6.3%

6.5%

Source: Bloomberg

Insurance Australia Group

IAG’s excellent 2012-13 result, with a 275% boost to net profits and a hike in insurance margins to 17.2%, gave the company more leeway to hand out a generous dividend to its shareholders.

The insurer took full advantage, handing out a final dividend of 25 cents per share that brought the full dividend for the year to a record 36 cents.

However, IAG isn’t expecting a repeat performance for the current financial year and set a cautious outlook, anticipating insurance margins to fall to between 12.5% and 14.5%.

With a payout ratio at around 64% – at the higher end of the company’s pledge for between 50% and 70% – tighter margins may make sustaining its 36 cents a share dividend a serious challenge.

Consensus forecasts are for a lower 29.2 cents a share total dividend in 2013-14.

“For someone to extrapolate that IAG is going to continue to pay dividends at the current level and/or increase them when earnings aren’t as robust have rocks in their head,” says Morningstar’s head of equities research Peter Warnes.

Warnes says he doesn’t see a problem in IAG reducing dividends when earnings haven’t been as robust, and that it’s more a question about educating shareholders than anything else.

“How else do you reward shareholders if you are in an insurance company and you know earnings are relatively volatile?” Warnes says. “When you have a good year, why shouldn’t they get a share in it?”

In such an environment Warnes’ investment strategy is to trade against the trend. He invests when insurance margins are low and when the combined operating ratio (COR) is high, driven by a lot of claims, and investment income is under pressure because of investment markets.

IAG

2013-14

2014-15

Earnings/share

44c

46.6c

Dividend/share

29.2c

30.7c

EPS growth

-4.4%

5.3%

DPS growth

-18.9%

5%

Price/Earnings

13.7 times

12.8 times

Dividend Yield

5%

5.3%

Source: Bloomberg

Coca-Cola Amatil

In its half-year report the company downgraded earnings guidance for the 2013 calendar year, expecting earnings before interest and tax to decline by up to 4% amid challenging trading conditions and a number of cost reduction initiatives.

But this didn’t stop chief executive Terry Davis appeasing shareholders with a special interim dividend of 2.5 cents per share on top of a 24 cents per share dividend. This was the same as the prior year and franked to 75% as the company’s Indonesian operations grew further within the group.

Excluding the special dividend, Coca-Cola’s payout ratio jumped seven percentage points to 81.4% in the interim and is anticipated to lift to 87% at year’s end.

“Terry Davis is flagging headwinds to Coca-Cola growing earnings and is handing money back,” Boubouras says. “While I don’t believe there will be a cut in Coca-Cola’s dividend, I think it will be harder for the company to grow it going forward.

“The year-end indicator is if the payout ratio marginally rises [from here] it could become potentially unsustainable – and that’s the signal to give out to everyone.”

Warnes thinks Coca-Cola’s projected payout ratio is too high as a theoretical number and the company might want to begin looking at it, but a solid balance sheet and cash flows puts the company in relative good shape.

Further, he anticipates the company will benefit from a shift in consumer sentiment post-election.

Coca-Cola Amatil

2013

2014

Earnings/share

69.7c

74.3c

Dividend/share

60.8c

63.4c

EPS growth

-5%

6.6%

DPS growth

8.6%

4.2%

Price/Earnings

17.6 times

16.5 times

Dividend Yield

5%

5.2%

Source: Bloomberg

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