Five income favourites

I received this request last week. I have had many like it.

“Many of us are looking for advice on which stocks to buy that will produce an income over 4% and be fully franked. Apart from the banks and Telstra, which everyone holds, we are looking for ideas to produce income with very little risk but with full franking”.

Of course, there are almost no investments with “very little risk”. I would only classify government bonds and bank term deposits in this category, certainly not any stocks. But I understand the intent of the question, lower risk stocks where the downside risk is not as high.

Using the following criteria, I have come up with five candidate stocks:

• No banks or Telstra
• No resource companies (because they are ‘price-takers’ and have almost no influence over the revenue they earn), although I do have a transport company involved in the resources industry
• ASX top 150
• Reasonably defensive (as demonstrated by a low beta and qualitative assessment)
• Expectation that earnings and dividends should continue to grow
• Forecast dividend yield higher than 2.5%
• Preference for franking; and
• Variety of industry sectors to support diversification objectives.

Here are the five (in alphabetical order).

  

1.     APA Group (APA)

Last price: $11.22

Broker Target Price: $11.48

FY20 Forecast Distribution 50c          

FY20 Forecast Yield: 4.5%, about 35% franked

FY21 Forecast Distribution 52.4c       

FY21 Forecast Yield: 4.7%, about 35% franked

Beta: 0.52

 

APA is a leading Australian energy infrastructure business. It owns and operates about $21bn of assets, including 15,425 km of gas transmission pipelines, approx. 29,000 km of gas mains, and is involved in gas fired power generation, gas processing, gas storage and solar and wind power generation. Current development activities include the expansion of the Orbost Gas Processing Plant in Victoria, and consideration of investment opportunities in North America, potentially via acquisition.

 

 

APA Group (2015 to 2020)

Source: nabtrade

 

In April, APA very marginally lowered full year guidance for EBITDA of $1,635m to $1,655m, up 3.8% to 5.2% on FY19. It reconfirmed a full year distribution of 50c per unit, implying a final distribution of 27c per unit. Franking will be around 35%.

This puts APA on a yield of 4.5%. On analysts’ forecasts, the prospective FY21 yield is 4.7%.

To quote a recent report from Citi: “Citi considers APA attractive with limited earnings impacts from Covid-19, medium term growth opportunities, strong liquidity and a defensive yield.”

 

2.     Aurizon Holdings (AZJ)

Last price: $4.64

Broker Target Price: $5.54

FY20 Forecast Distribution 27.1c       

FY20 Forecast Yield: 5.8%, about 70% franked

FY21 Forecast Distribution 28.9c       

FY21 Forecast Yield: 6.2%, about 70% franked

Beta: 0.63

 

The former Queensland National Rail, Aurizon hauls coal, iron ore and other bulk commodities from mine to port. It owns 500 locomotives, more than 11,000 wagons and services 2,670 km of rail track across Queensland, NSW and WA. Coal is the main commodity hauled, responsible for more than 50% of revenue.

 

Aurizon (2015 to 2020)

Source: nabtrade

 

Aurizon maintains an active capital management program, and after providing for sustaining and transforming capital, targets a dividend payout ratio of 70% to 100%. Surplus capital is either returned (via buybacks), or invested in new growth opportunities.

 

In early June, Aurizon provided an update to the market, saying: “While the Covid-19 pandemic has had some impact to coal demand in Asia and on the Indian sub-continent, it has not been material to date to volumes and the Company’s earnings. Accordingly, we re-iterate our underlying EBIT guidance of $880m to $930m for FY20”.

 

The major brokers are positive on the stock with 5 buys and 1 neutral recommendation. According to Morgans: “a solid dividend yield, strong balance sheet and resilient earnings are expected to support the stock”.

 

Aurizon is trading on a forecast yield of 5.8% for FY20 and 6.2% for FY21. Franking is around 70%.

 

3.     JB Hi-Fi (JBH)

Last price: $40.00

Broker Target Price: $40.53

FY20 Forecast Distribution 170.7c     

FY20 Forecast Yield: 4.3%, 100% franked

FY21 Forecast Distribution 138.7c     

FY21 Forecast Yield: 3.5%, 100% franked

Beta: 0.85

 

Unquestionably Australia’s best retailer, JB Hi-Fi is one of my favourite stocks. Despite the headwinds facing the sector, including the Amazon juggernaut, JB Hi-Fi has delivered in spades for shareholders. This chart from their February half year report says it all.

Dividends have increased from $0.89 for FY15, $0.99 for FY16, $1.18 for FY17, $1.32 for FY18, $1.42 for FY19 to a forecast $1.70 for FY20. The brokers are a little more circumspect about FY21, forecasting a reduction back to $1.39.

 

The pandemic has been a boomer for JB Hi-Fi’s Australian sales. Last week, it reported an increase in comparable store sales for the five months to end of May of 20.0% for its  Australian electronics business (JB H-Fi) and 23.5% for its Good Guys business. It lifted its full year profit guidance to be in the range of $300m to $305m, an increase of 20% to 22% on FY19.

 

JB Hi-FI (2015 to 2020)

Source: nabtrade

 

A risk with  JB Hi-Fi is that it is “fully priced” and perhaps things can’t get much better. While the earnings multiple is not high compared to the market at 14.5 times FY20 earnings and 17.5 times FY21 earnings, it is higher than the sector (Harvey Norman, for example, trades on a multiple of 12.7 times). Accordingly, the major brokers are a little circumspect, with 2 buy, 4 neutral and 1 sell recommendation (source: FN Arena).

 

But it has the track record, and while Richard Murray is the CEO, I reckon that is worth backing.

 

4.     Medibank Private (MPL)

Last price: $2.93

Broker Target Price: $2.84

FY20 Forecast Distribution 11.5c       

FY20 Forecast Yield: 3.9%, 100% franked

FY21 Forecast Distribution 12.2c       

FY21 Forecast Yield: 4.2%, 100% franked

Beta: 0.66

 

Australia’s largest private health insurer, Medibank Private, has made sound progress under CEO Craig Drummond in growing market share and customers, managing costs, and taking a lead to help drive industry reform. It has almost stopped the customer leakage from its main MediBank brand, while securing new customers under its low cost ahm brand.

 

But like other insurers, it faces significant industry head winds. These include:

• Declining health insurance membership as customers vote with their feet and say that private health insurance is “too expensive”. According to data from APRA, the number of Australians with private hospital cover fell by 9,400 in the December quarter. Only 44.0% of the population has hospital cover
• Pressure on premiums, with Government under pressure to limit premium increases
• Claims inflation, particularly relating to prostheses and with dental; and
• Age mix, as younger, healthier customers leave the system or delay taking out insurance, leaving older, less healthy customers.  

It has benefitted from the Covid-19 pandemic as policyholders/hospitals deferred elective surgery, and policyholders reduced expenditure on ancillary health services. This has enabled it to freeze any premium increase for 6 months, and make a commitment to return  any “permanent Covid-19 related benefits” to its customers. Against this, a small number of policyholders have suspended their policies. Its investment income has also been hit.

 

Medibank Private (2015 to 2020)

Source: nabtrade

           

In early May, Medibank re-affirmed that it expected health insurance earnings to be higher in the second half, and that its dividend payout ratio would be at the top end of the target range of 75% to 85%. According to FN Arena, the brokers now forecast a full year, fully franked dividend of 11.5c per share for FY20, rising to 12.2c in FY21. This puts it on a yield of 3.9% for FY20 and 4.2% for FY21

 

5.     Woolworths (WOW)

Last price: $36.67

Broker Target Price: $37.91

FY20 Forecast Distribution 96.1c       

FY20 Forecast Yield: 2.6%, 100% franked

FY21 Forecast Distribution 106.1c    

FY21 Forecast Yield: 2.9%, 100% franked

Beta: 0.66

 

Woolworths took the fifth spot by a nose over competitor Coles. While the latter is cheaper and trades on a multiple around 23 times forecast FY20 earnings compared to Woolworth’s 28 times FY20 earnings, it is not as good as business and a premium for Woolworths is warranted.

 

Woolworths (2015 to 2020)

Source: nabtrade

 

Woolworths has underperformed in a relative sense over the last six weeks or so as the market started to appreciate that panic Covid-19 buying was subsiding and Woolworths  was incurring additional costs. As a defensive stock, it also lost favour as the market’s attention switched to pandemic recovery stocks.

 

Looking ahead, competitive pressures in supermarkets have eased a touch following Kaufland’s withdrawal from Australia and a more rational approach to pricing. BigW’s performance is improving, while in liquor, the separation of the Endeavour Drinks business which includes Dan Murphys as well as the largely closed hotel business, has been deferred to calendar 2021.

 

Woolworths is no star on the income side with a forecast yield of 2.6% (fully franked) for FY20 and 2.9% for FY21. But it is relatively low risk, and the premium operator in its sector.