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Three dividend stock ideas for income investors

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A politician recently called for more COVID-19 “detectives”. I reckon the share market could do with a few more dividend “detectives”, given the challenges of finding reliable yield.

Dividends-per-share fell by about a quarter in the latest reporting season, broadly matching dividend cuts in the Global Financial Crisis, notes Macquarie Wealth Management.

Two thirds of companies Macquarie covers cut or suspended their dividend in FY20. That’s probably the worst of it, but it’s hard to see dividends roaring higher in FY21.

There’s too much COVID-19 uncertainty. Victoria looks like being in some form of lockdown for a few more months, possibly longer because of onerous rules to relax restrictions.

Government stimulus tapers after this month, the suspension of insolvency laws ends this year, and more bank customers will have to make loan repayments.

Sadly, many companies and consumers will go bust in the next six months. The recession will bite hard, especially in Victoria. Heaven help the economy if COVID-19 vaccine does not arrive.

Expect more pain for income investors in FY21. Yields on cash and fixed interest, already low, will edge lower. More companies will have flat dividend growth at best. Usual dividend sources – banks, listed property trusts and utilities – will remain out of favour due to COVID-19.

That said, the banks are a good buy at current prices for long-term investors – and even more attractive after this week’s global equities fall.

Also, sell-off in property trusts looks overdone, judging by profit-season results. However, a decent recovery in banks and listed property will take time as COVID-19 clouds the economy.

Income investors must be prepared to look beyond usual sources for yield. For some, that means venturing outside of ASX 100 companies to mid- and small caps. For others, that means identifying quality companies not normally bought for yield.

I’ve ploughed through the reporting season to find dividend ideas, using a four-step framework.

 

STEP 1

Step one sought companies that issued earnings guidance. As I wrote last week, it’s a good sign when companies disclose a range of expected earnings in such uncertain markets. The majority of companies that issued guidance beat market expectation and rallied.

 

STEP 2

Step two identified companies that lifted their dividend. It’s reassuring when a company achieves the magic trifecta – rising revenue, earnings and dividends – and has the guts to return more capital to shareholders. Doing so during COVID-19 impresses.

 

STEP 3

The third step considered valuations. It’s no good nominating a company with a rising dividend if it is overvalued. We want undervalued companies with good dividend outlooks – or even fairly valued companies for those who buy for yield (the focus should be on total return).
 

STEP 4

The final step was income traits. The stock must have a yield, preferably fully franked, that appeals to income investors. For example, Breville Group, among my favourite mid-cap stocks, lifted its dividend. But Breville is a growth rather than an income stock; its yield is too low.

Barely any stocks ticked all the boxes.

Here are three that income investors could consider:

 

1. Worley (WOR)

The global engineering firm matched market expectations with its FY20 profit (NPAT). The surprise was a final dividend of 25 cents per share. The market expected no dividend.

Other positives included strong growth in cash flow, debt reduction, cost savings and Worley’s leverage to renewables projects. The market liked the result.

The well-run company is doing a good job managing costs. Worley is positioned for an eventual recovery in capital expenditure on oil and gas budgets, which have been trashed this year. The boom in renewable-energy projects is another tailwind.

As the oil price tanked, so did Worley. From a 52-week high of $16.24, it crashed to $4.63 at the depth of the market sell-off in March. Worley now trades at $9.67.

At that price, Worley is yielding about 6 % in FY21 and 7% in FY22, on Morningstar numbers. There’s no franking, but the yield is highly competitive without it.

Morningstar values Worley at $12.50. Few sectors have been belted like energy, but the worst of the problems should be behind Worley, which has not issued guidance.

 

Chart 1: Worley

Source: ASX

 

2. Magellan Financial Group (MFG)

The wealth manager has been one of this market’s great growth stocks over the past decade. So including Magellan in an income story feels odd, even though its dividend growth appeals.

A tip is avoiding companies that have modest yield, without assessing future dividend growth. A company yielding 3% might look a lot better in a few years (at the current share price) if its dividend grows at a decent clip.

Magellan’s FY20 dividend rose 16% to $2.14. Within that, the interim and final dividend ($1.84) was up 22% up on FY19. Magellan’s 30.4 cents performance-fee dividend was slightly down.

Adjusted after-tax net profit grew 20% to $438 million, supported by solid growth in funds under management and fees. Magellan delivered another good performance in a market where COVID-19 pummelled wealth managers and sparked funds outflows.

Magellan has a strong brand and is adapting well to changing investor demands for cheaper, listed funds. I see Magellan increasing market share and assets managed in the next few years as global share markets recover. That’s good for its dividend growth.

Magellan has fallen from a 52-week high of $74.91 to $58.49. At the current price, it’s yielding a bit above 5% (with partial franking) in FY21 and nearer 6% in FY22.

More telling is Magellan’s potential to deliver double-digit growth in its DPS over three years. Few ASX 100 companies will do that.

The stock looks fully valued. But with risks to Magellan’s earnings and dividends growth on the upside, today’s valuation could prove undemanding in a year or two.

 

Chart 2: Magellan Financial Group

Source: ASX

 

3. Aurizon Holdings (AZJ)

Is Aurizon another dividend “trap” with inflated yield? At $4.30, the rail-freight group has a grossed-up yield of 7.3% in FY21, rising to 8.2% in FY22 on Morningstar numbers.

The FY20 result marginally beat broker expectations. Underlying earnings (Group EBIT) rose 10% to $909 million in FY20. The final dividend rose 10% to 13.7 cents per share.

Aurizon issued FY21 guidance of $830-$880 million. Although earnings will be down, it’s a good sign that Aurizon has provided guidance. It gives confidence in dividend forecasts for the company.

Granted, there are many risks. Aurizon relies almost totally on coal. That’s a short-term problem as COVID-19 trashes the global economy and, with it, steel demand. Thermal coal volumes are so far holding up, but weakening Chinese demand is weighing on coal prices.

Aurizon is guiding for flat growth in haulage volumes in FY21. It might do a little better due to contract wins, but near-term risks for Australian coal exports are rising.

Longer term, relying on coal’s fortunes is complex as the world moves faster towards renewable energies. Supporters say the coal industry has plenty of life in it yet as China, India and smaller developing nations require cheap power from fossil fuels. They are right, for now.

An immediate question is whether Aurizon can deliver an FY21 dividend only a little down on FY20 (the dividend will fall due to lower earnings guidance).

Morningstar expects Aurizon’s dividend to fall from 27.4 cents in FY20 to 26.1 cents in FY21, then rise to 29.3 cents in FY22. That delivers a forward yield of around 8 per cent after franking.

Aurizon has dropped from a 52-week high of $6.11 to $4.37. The stock looks fairly priced given coal-production risks. Provided the FY21 dividend only edges lower, Aurizon’s expected 8% grossed-up yield should suffice for income investors as they wait for the global economy to recover.

It wouldn’t surprise if Aurizon tested previous price support around $4 if the latest share market rout lingers. That would be an entry point for income investors willing to take calculated risks in search of higher yield.

 

Chart 3: Aurizon Holdings

Source: ASX

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. All prices and analysis at 14 September 2020. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.