Hunting down the dividend
Fund managers target the payers
Sasol has dropped its progressive dividend policy following oil’s dramatic fall over the past year. Dividends from other commodity companies are also at risk. That’s why Marriott Asset Management steers clear of resource stocks in its Dividend Growth Fund. In fact, it has six filters that it applies to the fund to ensure that it is left with the highest-yielding stocks that will continue to pay dividends into the future.
It’s not just commodity companies that Marriott filters out — it also excludes companies with a market capitalisation of below R2bn; those that are vulnerable to volatile economic conditions; and those that operate in unpredictable industries. So don’t expect to find MTN in the fund either.
The strategy has paid off for Marriott; its fund has ranked in the top quartile over numerous periods in the past 10 years. However, Marriott’s Duggan Matthews admits that a number of really good companies are excluded in the process.
“What we try to do is exclude companies that we feel aren’t predictable by nature,” says Matthews. “If their dividends aren’t predictable, their price appreciation is ultimately going to be unpredictable. The value of a company increases in line with its profit growth and its dividend growth.”
Sasol is moving back to its
former policy of having dividends covered by earnings, so those who had come to depend on sustained dividend flow from the group will have to adjust to lower payouts in the future.
Kumba Iron Ore’s earnings and dividends are under pressure because of the sharp slide in the price of iron ore over the past year.
However, BHP Billiton, which includes both oil and iron ore in its portfolio of commodities, plans to continue growing its dividends. This has resulted in a warning from Standard & Poor’s that it could have its credit rating downgraded.
“Market conditions are not favourable for commodity companies at the moment,” says Ivy Asset Management director Bruce Main. “If it is downgraded but maintains its progressive dividend policy, we’re happy as long as it doesn’t stand in the way of investments in projects. But BHP’s projects still have a long life and it has enough new projects it can fund with internal cash flow, so it could be a company worth looking at.”
Ivy Asset Management is another fund manager that generally doesn’t consider investing in a company that doesn’t pay dividends. “You’re basically getting no return for the commitment of your capital,” says Main. He believes the value of reinvesting dividends over the long term will guarantee superior returns. “Unfortunately in some of the bigger investment markets, corporate financiers would rather that companies commit their capital to projects and that comes at the expense of dividends.”
Main says where there is a commitment by management to pay dividends to shareholders — and directors have a fiduciary duty to make sure they do — then the company is less likely to squander capital on expansion that may not necessarily bear fruit in the long term.
“No management team in a company ever executes a business strategy and gets it right 100% of the time,” he says. “It makes management a little more circumspect on their investments if they are paying out dividends and have that responsibility.”
Sustainability of dividends is also important. When companies have cut back on their dividends, Main says, he’ll remain invested if there is a commitment to reinstate payments in the future. If the capital is being diverted into earnings-enhancing projects, it could ultimately result in higher dividend payments in the future.
“Generally we don’t like it, though. When a company was a dividend payer, like Anglo American, and suddenly stopped, the market reacted quite severely,” says Main. “Once the market is used to a dividend, don’t take it away.”
It’s not just the size of current dividends that Main keeps a watch on, it’s the potential for future dividend growth as the company expands and new projects come to fruition.
“We value the business on its future growth prospects, so while you might get a 1,5% yield at the moment, we also take a look at growth prospects, which may be substantially higher,” he says.
Ricus Reeders, a portfolio manager at PSG Wealth Sandton, agrees that apart from the current dividend payout ratio, the potential to pay out dividends in the future should also be considered. The small dividend payers of today could be the high yielders of the future.
“The yield is good for the short term, but if you think back 10-15 years, technology companies globally paid no dividend whatsoever,” he says. “These days the tech sector is probably the biggest dividend payer.”
In SA, there is very little to choose from in the technology space, however. One example is EOH. Although its dividend yield sits at just 0,75%, as long as growth continues on its current trajectory, Reeders says, this is a company that could start returning more cash to investors. The same goes for Naspers; its dividend yield is just above 0,2% as strong cash flows from its TV operations are used to fund its fledgling e-classifieds and e-commerce businesses. That could change, though.
“The main point is not to be too concerned if the yield is low right now,” Reeders says.
Despite their low payout ratios, EOH and Naspers are in the top 10 constituents in the Coreshares DivTrax exchange traded fund, with respective weightings of 4,9% and 4,7% in the ETF.
“The yield is low, but the dividend is consistent and has grown and our product focuses on that growth,” says Gareth
By targeting dividends, investors benefit from the power of compound, by reinvesting the dividends
Stobie, general manager of Coreshares at Grindrod Bank. “Naspers is a bit of an outlier, though. The portfolio on average pays a yield higher than the general market, as you’d expect.”
Coreshares DivTrax tracks the S&P Dow Jones SA Dividend Aristocrats Index, which targets stocks which have maintained and/or grown their absolute dividends over at least five years. The index is reviewed twice a year to ensure that dividend coupons are being maintained or grown, including interim dividends.
Stobie says by targeting dividends investors have the certainty of having cash in hand today and benefit from the power of compound by reinvesting the dividends.
DivTrax includes the low-yielding Naspers among its constituents.
The Satrix Divi ETF includes some of the commodity stocks whose dividends could be under threat from weak commodity prices. Kumba Iron Ore, Sasol and BHP Billiton all feature in the top 10 holdings, with basic materials making up more than 30% of the fund. It replicates the FTSE/JSE Dividend Plus index, which measures the performance of the top 30 high-yielding large and mid-cap companies on the JSE, including real estate companies. It’s also reviewed twice a year, in June and December, so expect some changes from next month.
That said, both ETFs have an average yield of about 4%, well above the average 2,9% yield for the FTSE/JSE’s All Share Index.
Although Ivy Asset Management was overweight in commodity companies in the early 2000s, when they paid large dividends, this is no longer the case. The industry has no control over the price of its end products. Main says Ivy lightened its commodities holdings in 2010 and only now believes that value is returning. However, it still prefers companies that have more predictable cash flow.
“If you look at companies that can control their product prices, these include branded food companies and IT companies that have intellectual property,” says Main. “These companies have far more predictable annual income and cash flow and ultimately if you are going to be paying a dividend you need that.”
An example of a company with strong branded products is Pioneer Foods, which Ivy Asset Management acquired shares in when it traded on the OTC via the business Agrivoedsel. You could buy it for R15 then. It’s now trading north of R170 on the JSE and investors have been rewarded tenfold with the growth in its dividends since then.
“Another example is Zeder,” Main says. “Though the dividend is a little lower, what is very important is that the company is growing. If you can get your original capital back in dividend income in the next 10 years, you can reinvest that in another four to five companies and do the same again. The multiplier effect of that dividend stream into the future is astounding.”
Marriott also favours branded companies and those with strong cash flows and pricing power. Matthews says a good portion of the portfolio is invested in Bidvest, “a very stable, solid company”. Retailer Mr Price also features. “So are the food manufacturers and food retailers like Spar, which are all companies where consumers have to spend their money. Because of the basic necessity nature of those industries, they’re able to produce
While the financial sector is a favourite for dividends, growth may be more choppy as it is very dependent on the market itself
consistent dividends and consistent returns for investors over time,” says Matthews. “Internationally, there’s a bit more to choose from. You’ve got companies like Nestlé, Johnson & Johnson, Pfizer, Procter & Gamble, all with exceptional track records going back 25-30 years or even longer.”
Banks and insurers are among the high yielders that Marriott includes in its Dividend Growth Fund. “Yields of companies like Standard Bank and Nedbank are close to 4%, which is quite attractive if you look at the All Share’s yield of around 3%,” says Matthews. “You’re also likely to see life insurers; MMI and Liberty Holdings for example, are yielding close to 4,5%.”
The four big banks are relatively progressive dividend payers. Main says they are also expanding further into Africa, where a lot of their future growth will come from. In some cases, this could be at the expense of higher dividends.
“A lot of the money that could be paid back is being invested in future growth in Africa, so I would prefer to take a longer-term view on those expanding because of the constrained growth here in SA,” he says.
The financial sector is a favourite for dividends, but growth may be more choppy as it is very dependent on the market itself, says Reeders.
“Financial institutions are not going to reinvent the wheel, so the yield may be good at some times and bad at some times,” he says.
Many investors believe telecoms companies are ex-growth. Reeders, however, believes they will grow and evolve thanks to advances in technology and will continue to be a source of decent dividends. Both Vodacom and MTN currently yield more than 5%.
The health sector is another good source of dividends, including Life Healthcare and Netcare, but Reeders warns against overpaying.
Life Healthcare has a dividend yield of 3,7% and Netcare offers a 2,1% yield, but they are trading on 22% and 25% historical earnings respectively.
“It’s not good getting these dividends at too high a price,” he says. “Over the longer term health care may be a good place to be, but you have to balance out capital growth with dividend growth.
“If your capital growth is flat to negative, dividend growth won’t make up for it.”
Apart from listed companies, Main says, the over-the-counter market was also a good source of dividends for investors. However, new rules being introduced by the Financial Services Board are curtailing that market.
“Senwes, for example, is listed on the OTC market. Close to a decade ago it was roughly 95c. You would have got your investment back almost fourfold just in dividends,” says Main. “The shares are now trading at close to R12, so your capital has also appreciated. It’s one of our best-performing investments outside the JSE, and a lot of that return has to do with the dividends.”
Main says the multiplier effect of reinvesting dividends will have a huge effect on ultimate returns. For example, R500 invested in stocks every month for 40 years that delivered an annual return of 14% would be worth about R8,8m in 40 years’ time. But if the equities yielded an extra 2% in dividend income and those were reinvested, the end result would be R15,5m.
At Marriott, local and international equity funds are focused on providing a reliable dividend stream to investors, which leads to more predictable capital growth over the long term, says Matthews. It’s not just for older investors looking for income.
“Because of the quality of these companies and the ability to grow their earnings and their profits consistently over time, that income stream is likely to grow in excess of inflation,” he says.
Whichever way you cut it, reinvesting dividends will add to long-term capital growth. However, with the market looking expensive, Reeders says investors have to be careful about the price they pay for yield.
They still prefer companies that have more predictable cash flow
Duggan Matthews … We try to exclude companies that we feel aren’t predictable by nature.
Ricus Reeders … The potential to pay out dividends in the future should also be considered.
Gareth Stobie … By targeting dividends investors have the certainty of having cash in hand today.