Hear the latest from Scott Kelly, Portfolio Manager for the DNR Capital Australian Equities Income Portfolio as he gives his top 4 picks for income investors.


Well, October was the sixth consecutive month of high bond yields with the U.S. 10-year nudging 5% over 150 bps higher over that period, and in Australia, the increase has been even steeper. There’s been three key factors driving yields higher. Firstly, it’s a better than expected growth in the U.S. economy. Secondly, it’s that inflation is still too high and sticky. Finally, it’s the U.S. fiscal funding requirements. Now, of course, bond yields have retraced over the last couple of weeks, and the likelihood is that bond yields and potential interest rates too have peaked. However, the market’s now grappling with the realization that interest rates are set to be higher for longer.

From a valuation perspective, having more assurance in the long-term bond yield provides investors with more confidence in how much they’re willing to pay for each dollar of earnings. At the same time, central banks’ efforts to lift rates, that’s expected to have an economic impact, and so higher rates creates uncertainty regarding the future level of profitability for the market. So with the capitulation of markets recently around the idea of higher for longer, some companies have moved quicker than others to price in high bond yields. Some of these stocks now present good value on risk-reward metrics, and these are resilient quality companies that have de-rated where we can be confident about earnings and we can therefore buy these stocks with greater confidence.

Well, the first stock is Telstra. It’s Australia’s leading telco, most extensive portfolio of network assets. It has about 50% share of the mobile market, which also accounts for about half of Telstra’s earnings. We believe the market is underestimating the ability of the industry, and in particular, Telstra to grow its mobile earnings in the near term. Telstra’s competitors are currently generating earnings below their cost of capital. So there’s a clear incentive for all mobile participants to grow earnings via price rises rather than by competing for market share. A couple of weeks ago, ALDI mobile announced its prices are rising by 10 to 20%, and this provides more headroom for the others to follow, we expect into the new year.

In terms of Telstra’s infrastructure assets, we think the market is fundamentally undervaluing these, and we believe there are cost efficiency opportunities, better supply negotiation potential and productivity improvements through the use of AI. So we think the stock can continue to grow its dividend over the next few years, which the market is underestimating. That combination of a 7% gross yield growing at high single digits over the next three years is very attractive.

Next, there’s The Lottery Corporation, and it operates lotteries and keynote products throughout Australia, which are underpinned by long dated licenses. Whilst there’s some volatility around jackpot sequencing, at the end of the day, it’s economically resilient, operating in exclusive markets, delivering high recurring and relatively predictable revenues. So in short, it’s a high quality well-managed cash generative business. Once again, we think the market is underestimating the continued product evolution. For example, it’s working on a new Friday lotto game, and it’s continued digital penetration, which provides better cost to, serve customer personalization as well as technology and data insights.

Its balance sheets under geared, which provides flexibility for M&A and specifically the Victorian license renewal and or capital management. Its EBITDA multiple is around 14 times, and we compare that to other high quality capital like defensive businesses that trade on EBITDA multiples of more than 20 times. The stock’s gross yield of 6%. We’re expecting high single digit growth over the medium term. It’s an attractive stock for income investors.

Well, Scentre Group owns, manages and develops the largest and highest quality retail property portfolio in Australia. There will be pressure from higher interest rates and the potential of a softer underlying consumer. But we think these are factors that are already captured in consensus earnings as well as the stock price. We think Scentre’s network of assets should remain relatively robust. Management is high quality. They’ve been driving more value from an improved tenant mix. Occupancy has remained resilient. Pressure on rents is diminishing and development opportunities are also emerging. In fact, the return of development spend we think is a key positive as it signals the potential value add to their strategic locations.

In terms of valuation, it’s currently trading at a 20% discount to its NTA, and that includes no value for its management rights or development potential. It’s delivering a 7% dividend yield. We expect mid single digit growth. So in short, we think it’s a materially undervalued stock and investor perceptions are overly pessimistic.

Well, IPH is currently the largest active position we have in the income strategy. IPH is the largest intellectual property services group in Australia, New Zealand, Asia Pacific, and now Canada. The company has very attractive margins. It’s highly cash generative. Its capital light delivers attractive and improving returns on capital over time. Its underlying earnings are defensive, patent volumes are driven by corporate R&D investment and corporate R&D spending has been very resilient throughout economic cycles. We think demand for IPH should continue to be supported by emerging technologies and government regulation as well as globalization.

But I think a key success factor for IPH has been its acquisition strategy, and in particular its ability to extract synergies and other gains from brand integration. We think M&A will continue to be a key driver of the stock, and it’s simply not priced in. We see opportunities for additional bolt-on acquisitions in Canada specifically right now, as well as entry into other new secondary IP markets like Brazil or potentially South Africa. Then there’s investments in adjacent businesses in other associated services, patent renewals and IP related software.

The stock’s been particularly weak recently. Investors have been focusing on market share losses in Australia. We think that misunderstands the business’s consolidation strategy, which has been delivering EBITDA growth despite the market share declines. It also only accounts for a small proportion of the overall business. The stock has now de-rated to less than 15 times PE compared to a historical average of more than 20 times. It will deliver a 6% gross yield and growing at mid-single digits. That doesn’t take into account further M&A, which we think is likely. So a key standout we think for the income strategy and for income investors.


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