Why we like MQA, IPH, CTX and NAB

Australian investors need to consider a higher allocation to Australian equities with strategies focused on sustainable and growing income generation to maximise income in 2018 and beyond according to DNR Capital portfolio manager Scott Kelly.

“Despite our underweight positions in the big 4 banks and Telstra the12-month forward yield of the DNR Capital Income Portfolio is currently around 6.3% including franking,” said Kelly.

“Assessing a company’s dividend sustainability and growth potential is the core focus of our Income Portfolio. We want to have reasonable certainty of a company’s underlying cash generation and dividend profile over the next 3-5 years,” said Kelly.

DNR Capital categorises income generating companies as the following:

Growers: A company that is delivering below market income, however delivers above market income growth. For example, Macquarie Atlas Roads Group (MQA).

Compounders: A company that is delivering an average market income, with sustainable above market income growth. For example, IPH Limited (IPH).

Cows: A company with a solid balance sheet and capital management potential (i.e. – higher payout, special dividends, buybacks). For example, Caltex Australia Limited (CTX).

Yielders: A company delivering above market income, however with minimal (or no) income growth. For example, National Australia Bank (NAB).

“Income investors can be attracted to high yielding companies on the stock market, however a high yielding company can often indicate structural or cyclical challenges and the potential for a dividend cut if it is not sustainable,” says Kelly.

“Whilst yields of around 6% (excluding franking) in the Media, Retail, Telecommunications and Bank sectors appear attractive, they are all facing significant structural challenges and indicate that both dividends and capital may be at risk:

  • Media / Broadcasters stocks are facing substantial competition from Facebook, Twitter and Netflix;
  • Retailers have to weather the entry of Amazon;
  • Telecommunications face heightened competition in a post-NBN world and other technological advances; and
  • Banks are facing an over-leveraged consumer, property headwinds, cyclically low bad debts, regulatory / political risks, as well as technological threats.”

The following chart shows the relative performance of the portfolios ‘Compounders’, ‘Cows’, ‘Growers’ and ‘Yielders’ (excluding franking) over the last 5 years, highlighting that a portfolio focused on yield alone would not have resulted in an optimal outcome for investors.

Growers: Gross dividend yield below the ASX200 Industrials Index with dividend yield growth above the ASX200 Industrials Index.

Compounders: Gross dividend yield within 1% of the ASX200 Industrials Index with dividend yield growth above the ASX200 Industrials Index.

Cows: Net Debt / EBITDA less than 1.5x and FCF yield above the ASX200 Industrials Index.

Yielders: Gross dividend yield above the ASX200 Industrials Index with no or declining dividend yield growth.

DNR: DNR Capital Australian Equities Income Portfolio

 XJI: S&P/ASX200 Industrials Accumulation Index

About DNR Capital

Founded in 2001, DNR Capital is an Australian investment management company that delivers client-focused, quality, investment solutions to institutions, advisers and individual investors. DNR Capital is a signatory to the Principles for Responsible Investment (PRI).

DNR Capital’s leadership in the Separately Managed Account (SMA) sector was reaffirmed by being named SMA of the year at the Money Management Fund of the Year Awards 2017 for its Australian Equities High Conviction SMA.

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IMPORTANT NOTE: The information relating to DNR Capital has been prepared by DNR Capital Pty Ltd, AFS Representative – 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658. Whilst DNR Capital has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and you must make your own enquiries concerning the accuracy of the information within. The information in this document has been prepared for general purposes and does not take into account your particular investment objectives, financial situation or needs, nor does it constitute investment advice. Before making any financial investment decisions you should obtain legal and taxation advice appropriate to your particular needs. DNR Capital will not be responsible or liable to anyone who acts or relies upon anything contained in, or omitted from, this document. Past performance is not indicative of future performance.