2017 Reporting Season Wrap: How did income fair?
In April my colleague Dr Peter Gardner wrote about the differences between a diversified portfolio and a portfolio of banks/Telstra. The benefits of investing in a diversified portfolio were certainly highlighted this reporting season. Commonwealth Bank (CBA) and Telstra, arguably the most commonly held retail stocks in the land, disappointed us big time. CBA share price fell 9.5% in August 2017 whilst Telstra fell 10.5% – not a lot of diversification there, although the reasons for the falls were quite different.
CBA actually delivered a reasonable result in our opinion, lifting cash NPAT 5%, lifting its final dividend 4%, and mildly beating analyst expectations. But we believe the share price fall had nothing to do with CBA’s underlying earnings. AUSTRAC launched a court case against CBA for CBA failing to report approximately 53,000 cash transactions of more than $10,000. Not only does CBA have the potential to pay a very substantial fine, the issue raised real concerns about CBA’s governance and disclosure. In response, CBA’s Board has cut senior executive bonuses and announced that CEO Ian Narev will be departing earlier than expected at the end financial year 2018. Whilst clearly this is an important issue, we don’t think the AUSTRAC affair will damage the underlying CBA franchise and believe the market has more than fully priced in the impact.
Telstra, on the other hand, disappointed the market by announcing a much larger than expected cut in its future dividends. It should be noted that current dividends were not affected. Telstra declared a 15.5c fully franked final dividend, making a total of 31c fully franked dividend for the year. Telstra has pre-announced that next year it will slash its full year dividend to 22c a share fully franked – a 29% reduction – and expects to maintain dividends at that level going forward. Even though the market had speculated that Telstra was likely to cut its dividend – the share price has been falling for the past 2 and half years – few predicted the size of next year’s dividend cut. But again we believe the market has now pretty much priced all the bad news into Telstra, with the stock now trading on a forward dividend yield of approx. 6% or 8.6% on a gross basis using Telstra’s closing August share price of $3.67.
So if Telstra was your only stock holding, your dividend income will be 29% lower going forward, or if you held a portfolio of 50% Telstra and 50% CBA, your income will likely fall 12-14% next year.
The impact of these falls on a diversified portfolio will be much smaller. Whilst Telstra is a large stock and its dividend cut next year is large, we estimate that at the S&P200 Index level, Telstra’s future dividend cut should only reduce index level cash dividends by around 8bp (0.08%) and gross dividends including franking by around 12bp (0.12%), which is less than a 2% overall decline in index income. And that’s before we take into account changes of other stocks. And overall most other stocks announced dividend increases.
Resources dominate dividend increases
Resources stocks filled all the top spots for the biggest increases in dividends. S32 took the cake, lifting cash dividends over 500% and gross dividends rose even further (+777%) as it fully franked the final compared to last year’s unfranked dividend. Oilsearch (+230%), BHP (+193%), RIO (+133%) and Fortescue Metals (+108%) all increased dividends strongly on the back of a full year of higher commodity prices and a continued focus on reducing costs. There were also some good lifts outside the resources sector, with IAG lifting dividends 54%, Woolworths +52%, AGL +39%, Wesfarmers +26% and JB Hi-Fi +26% to name just a few of the better dividend results in our view.
Overall, we tracked 129 stocks within the S&P/ASX 200 making up 63% of that index by value, and we found 2/3 of stocks increased dividends whilst 1/5 reduced dividends. The average company increased dividends by a healthy 18%, although when we look at the median change it amounted to a much smaller 5% increase.
When one adds up the index level impact of all these dividend changes, we estimate index level dividends went up approximately 22bp (0.22%) in cash terms, or 30bp in gross dividend terms including franking. So other companies have more than made up for next year’s 8bp/12bp dividend falls at Telstra. In fact, BHP’s current year final dividend increase alone essentially made up for next year’s expected fall in Telstra’s dividends.
Figure 1. S&P/ASX 200 Dividend Changes in August 2017 Reporting Season
Source: Plato, Iress
Apart from CBA and Telstra, there were a fair share of other disappointing results. Vocus topped the bill announcing a $1.5B write-down, cutting dividends completely and losing the interest of private equity players all contributing to a 34% share price fall in August. Seven West Media wrote down $1B in assets and cut dividends 50%, with its share price falling 14%. Two other disappointing results actually came from stocks that raised dividends. Domino’s Pizza, a growth stock rather than an income stock, raised dividends 16%, but its earnings growth rated failed to match lofty expectations and the share price fell 19% over August. Bluescope Steel also disappointed, not because of its good current results where it announced a 67% increase in dividends, rather it announced that this coming year’s earnings would be lower.
One common theme amongst companies, and a potential risk factor for earnings and dividends going forward, was the widespread warning from CEOs about the cost of energy in Australia. Miners, steel makers and retailers warned of significant increases in gas and electricity prices impacting costs. For example Woolworths will be looking to increase their focus on energy efficiency and consider investing in solar panels on the roofs of their stores.
Despite some hiccups, the dividends of the S&P/ASX200 were strongly underpinned in the latest reporting season. Yes, Telstra has announced it will be cutting its dividend by 29% next year, but overall the average stock that reported dividends in August lifted dividends by 18%. Next year, Telstra’s dividend cut will take 8bp off the cash yield of the index, and 12bp off the gross yield, but this season overall net increases at the index level amount to a 22bp increase in cash dividend yield and 30bp increase in gross dividend yield, more than wiping out Telstra’s future expected falls in dividends. The future for dividends still looks bright post Telstra’s pre-announced dividend cut.
 “Plato Australian Shares Income Fund V a Portfolio of Banks/Telstra.
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