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Company reporting season wrapped up last week. Here are five stocks that stood out from an income perspective and should be able to keep delivering in the medium term.
While “high” income is important, the stability or certainty of that income is just important. I like stocks that have annuity style characteristics – you can have a high degree of confidence that the income will be paid.
Normally, a resource stock wouldn’t qualify for this list because it has absolutely no control over the price it receives for its output. It is a price taker, and we know that commodity prices can be very volatile. The recent BHP experience, where it tried to be an “income stock” by promising a progressive dividend, is a salutary reminder.
But I think Woodside Petroleum, owing to its cash flow, balance sheet and commitment to sell down projects, is in a different category and I have included it in the list.
The other point to make is that income stocks won’t star in a bull market. They will typically underperform. Conversely, they should do better in a bear market and preserve more of your capital. In the main, they will be low beta (less volatile) stocks relative to the rest of the market. Boring, but hopefully dependable.
Here are my standouts.
Gas pipeline operator and energy infrastructure business APA Group (APA) delivered a solid set of results with revenue up 4.1% and EBITDA up 4.3% to $787.7m. It raised guidance by saying that the full year EBITDA would come in at the “upper end” of the previously advised range of $1,550m to $1,575m.
The half year distribution of 21.5 cents per share is up 0.5c on the corresponding period of FY17. 7.47c of the distribution is franked, 5.0c is unfranked, and 9.03c is a capital distribution (not taxable).
For the full year, APA has guided to q total distribution of 46.5c – an effective yield of 4.7% (based on a market price of $9.95). Not a super yield, but very low risk
The stock price has rallied strongly this year (it was $8.50 on 31 December) and in may be getting a little overbought. But it was also the subject of a recent takeover bid at $11.00 per share, knocked back by the Treasurer on “national interest grounds”.
APA Group (APA) – 3/18 to 3/19
Supermarket giant Coles didn’t report well, but its share price fell by more than 9%, putting it into buy territory. EBIT fell by 5.8% to $733m. Most of the fall occurred in the convenience division (where Coles has been renegotiating the petrol supply arrangement with Viva Energy).
In supermarkets, EBIT grew very marginally from $600m to $602m. While sales continued to grow (Coles was able to report its 45th consecutive quarter of comparable store sales growth), cost pressures saw its EBIT margin (earnings as a percentage of sales) deteriorate by 0.12% to 3.7%. After beating Woolworths in the “supermarket wars” in the September quarter due to the success of its Little Shop promotion. Woolworths regained the lead in the December quarter, increasing comparable store sales by 2.7% compared to 1.5% for Coles.
Pressure in the convenience division should ameliorate following the completion of a new alliance agreement with Viva Energy. Coles will no longer have direct exposure to retail fuel price movements but rather receive a commission on fuel volumes achieved. Coles is positioning Express to be Australia’s leading convenience retailer.
Coles won’t pay its maiden dividend until September 2019. This will cover the period post the demerger from Wesfarmers (from 28 November 2018 to 30 June 2019). For the next full financial year (FY20), the brokers (source: FN Arena) have forecast a full year dividend of 55.6c, putting Coles on a projected yield of around 5% fully franked. The company has further confirmed that it expects to maintain a payout ratio of 80-90%.
Coles is not going to shoot the lights out. The industry is going to remain super competitive with discount supermarket chains Aldi, Costco and Kaufland making life hard for Coles and Woolworths. But it is trading at a discount to its competitor Woolworths (which is appropriate), and following the fall in price, starting to look attractive trading on a multiple 17.3 times forecast FY20 earnings. This is low for stock in the “boring” consumer staples sector.
And that sums up Coles. Boring and reasonably predictable, with annuity like characteristics. A buy around $11, sell around $13.
Coles (COL) – Nov 18 to Mar 19
I have never been a big fan of Medibank Private, Australia’s leading health insurer. But under CEO Craig Drummond’s leadership, it is addressing its key failing, a declining number of policyholders. Thanks to the success of its “discount” AHM brand and a focus on improving customer outcomes, total policyholders rose by 6,400 tin the first half leading to a small increase in market share. This was Medibank’s first market share increase since listing in 2014.
Financially, group net profit after tax declined by 15.4% to $207.7m for the half year due to a steep drop in investment income. Operating profit, which excludes investment income and intangibles, rose 2.4% to $293m.
On the expense front, Medibank continued to make progress by improving the management expense ratio by 10bp to 8.5% (this is the proportion of health insurance premiums that go to meet administration and sales costs).
Medibank increased the half year dividend from 5.5c to 5.7c per shares (fully franked). For the full year, it is expected to pay total dividends of 13.3c a share, putting the stock on a yield of 4.6%. The Board has reconfirmed a full year payout ratio at the top end of its target of 70% to 80% range.
The health insurance industry still faces key headwinds to do with declining participation rates, medical inflation and pressure on premiums. The ALP has said that if it wins government, it will cap premium increases to 2% pa. This all said, it looks like Medicare has turned the corner and while it is unlikely to see material earnings growth, it is well placed to deliver a stable, possibly marginally growing dividend.
Medibank Private (MPL) – Mar 18 to Mar 19
One of my favourite stocks, toll road operator Transurban (TCL) delivered a predictable but marginally weaker set of results than forecast. Top line toll revenue growth increased by 9.3% to $1,286m and EBITDA by 9.8% to $1,001m.
However, average daily traffic only grew by 2.7%. Sydney recorded growth of 2.1%, Melbourne 4.6%, Brisbane 0.3% and North America 1.4%. Perhaps consumers are growing weary of paying tolls!
Yet the beauty of the Transurban model is that legislated toll increases (at rates above inflation) plus a small increase in traffic plus an improvement in mix (more higher paying trucks) plus an expanding set of toll roads delivers a 9.3% increase in revenue.
Additional information: View nabtrade's Meet the Executive interview with Transurban CFO Adam Watson.
With the revenue increase came an increase in the distribution to 29.0c per unit (up 5.4%), and a reconfirmation of full year guidance of distributions totalling 59.0c per unit. The franked component will be around 5% (1c per unit in the first half).
There was some concern from analysts that Transurban was digging into capital to pay the distribution on an increased unitholder base (it raised capital earlier in the year to fund the purchase of 50.1% of WestConnex), and a further delay to the opening of the North Connex tunnel in Sydney (now pushed back to 2020).
Putting these concerns to one side, Transurban has an excellent track record in delivering major projects. There are nine projects due to complete in the next five years to drive revenue growth (and distribution unit growth), including the West Gate Tunnel in Melbourne, North Connex and West Connex in Sydney, and freeway extensions in North America.
Transurban is a stock to buy in market weakness. At $12.48, it is yielding 4.7% and is 17c higher than the broker consensus target price of $12.31 (source: FN Arena). But it is a stock to buy.
Occasionally, this opportunity comes when interest rates move higher as some in the market view the stock as a bond substitute. However, Transurban is not immediately exposed to higher rates as its debt is 98% hedged and has an average tenor of 9.6 years. Longer term, it would have to refinance debt as it matures at a higher interest rate, but there is no material exposure to rates in the short to medium term.
Transurban (TCL) – 3/18 to 3/19
As I said at the outset, I wouldn’t normally include a resource stock in a list of ”great income” stocks. But I think Woodside is an exception, given its strong cash flow, balance sheet and commitment to sell down stakes in key development projects (Scarborough and Browse).
Woodside reported a full year profit (it has a December 31 balance date) of US$1,364m, up 28% on 2017. The combination of production up 8% to 91.4 million barrels of oil equivalent (MMboe) and a 23% increase in the realised price for its LNG, oil and gas delivered a 32% increase in operating revenue to US$5,240m.
The business generated US$1,524 in free cash, up 83% on FY17. Gearing was reduced to just 12%, and the company will pay a final dividend of US91c per share, up from US49c in FY17. For the full year, the dividend is US144c per share, up 47% on the US98c paid for FY17. This represents about 95% of Woodside’s underlying profit, well above the company’s target of 80%.
Woodside said that it was paying a higher dividend “to reflect our strong operating cash flow for the year due to higher realised prices, reliable production and low operating costs. Woodside continues to target a payout ratio of 80% of underlying NPAT subject to market conditions and investment requirements.”
The dividend of US144 cents (approx. A$2.00) represents a yield of 5.6%, fully franked! Now, you need to factor in a lower dividend in FY19 (the brokers currently forecast US126.9 cents), and there is some risk with that. While Woodside has guided to a small increase in production to 88 – 94 MMboe in FY19 and around 100 MMboe in 2020, achieving its earnings target will ultimately still come down to the oil price, which drives the LNG prices Woodside receives. The former is currently very well supported around US$50 per barrel.
Higher risk, but worth considering. Maybe a stock to buy when the market (or oil price) is in retreat.
Woodside (WPL) – 3/18 to 3/19