Stock Review

We asked our team of analysts to nominate two stocks with dividends that could be relied upon through thick and thin – and we got some interesting responses.

Dividends are very dear to our hearts at The Intelligent Investor. In the good times they’re our inspiration, and in the bad times they’re our rock and our salvation. Over the long term, a company’s distributions define its value, and in the short term they can ease the pain of waiting for that value to be realised.

Right now there’s a lot of pain to be eased, so it’s no surprise to find ourselves double-checking the safety of our dividends. But it’s at times like these that investors need to be expanding their horizons in the search for opportunities, and with yields shooting up, a dependable dividend could be a good pointer towards value. If you can find a rock solid investment yielding 5–6%, with prospects for growing along with the economy over the long term, then you don’t need much more for a decent investment.

So I asked each of our analysts to nominate ‘two stocks with dividends you can count on through thick and thin’. I explained that ‘they may not be buys at current prices and the yield may not be sensational, but they’re the ones you’d back to maintain or even increase their dividends in tough times.’ To make things more interesting, I also stipulated that the yield should be at least 4%.

Wide array of stocks

The rules of engagement immediately ruled out high-yielding recommendations such as Mortgage Choice, Perpetual and Infomedia – all of which could see their dividends cut in the near future. And the 4% baseline also discounted easy choices like Cochlear and Woolworths.

We’ve been rewarded with a wide array of stocks. It’s also been interesting to see how people went about making their selections. Some focused on business quality; others took more notice of payout ratios (dividends paid as a percentage of earnings). Other things being equal, a lower payout ratio will afford a greater degree of safety, but a higher-quality business should have less need of a safety net.

Now, with the caveat that these stocks are not specific recommendations (as only reliability of income has been considered, not the overall issue of valuation), I’ll hand over to our team of analysts.

Gareth Brown

I can envisage a situation where Westfield Group might cut its distributions, to buy up distressed assets, but that kind of cut wouldn’t bother me. Looking at its ability to pay continued distributions, though, I’m reasonably comfortable suggesting this one.

I also think Corporate Express is a pretty good bet. Its dividends are well covered by earnings and it has a market-leading position. The main things that might upset the applecart are problems with its warehouse amalgamation, bugs in the new enterprise resources planning system, or a deep recession in Australia. All are bearable risks, in my opinion.

Nathan Bell

Envestra owns 19,595km of low-pressure gas distribution pipelines that connect high-pressure transmission pipelines to our kitchens and hot water systems. The company is highly geared and fear has pushed the yield up to 13%, but thousands of customers practically guarantee demand, which makes the distributions look pretty solid.

Although slower retail spending might temporarily curb sales at Bunnings Warehouse, that shouldn’t affect the rent it pays Bunnings Warehouse Property Trust. Unfortunately that’s not lost on sharemarket investors and, in contrast to Bunnings’ everyday low prices, the trust is trading on a yield of 7%.

James Greenhalgh

I found this task harder than it sounds. Few businesses are bulletproof and those that are, such as Woolworths, usually have yields of less than 4%. So I’ll go for Westfield, which probably won’t suffer too much even with a severe retail downturn. And distributions have been held steady for a few years while shopping centre development has continued, so the next leg of income growth is coming.

My second pick is Harvey Norman, which incidentally is also a big property owner. But with relatively low debt levels, a payout ratio of less than 50%, and a history of picking up market share in downturns, it’s a very solid business. 

Tim Searles

I expect Australians will continue using taxis when times are tough. With an impressive track record, a monopoly and conservative finances, Cabcharge should do well through thick and thin [and we’ll let it squeak through with a 3.94% yield, but don’t do it again – Ed].

Although more exposed to the economic cycle, my other choice is Flight Centre. It’s also a quality business with good management and a conservative balance sheet. The latter was a key consideration for both my choices and ruled out a surprising number of options. If there’s a recession it might be hard for companies with indebted balance sheets to survive, let alone maintain dividend payments.

Steve Johnson

I found this exercise much more difficult than initially expected. Most high-yielding companies have vulnerable dividends, and the companies I’m confident will maintain their dividends, like Woolworths, aren’t yielding enough.

I started out looking for stocks with a large buffer between their earnings and the dividend, but couldn’t get comfortable with the available opportunities. So I’ve settled on two companies with high payout ratios (in both cases more than 100% of available cash) but where I’m confident of earnings growth over the next couple of years.

Macquarie Airports is my first pick and Telstra my second, though I’m a bit concerned about the capital intensive nature of the latter.

Tony Scenna

The banks seem to pull enough rabbits out of the hat when things get tough to avert the unpopular option of cutting dividends. Already we’ve seen the major banks, under some duress in recent months, maintain or even increase cash dividends. That said, they’ve funded these payments via underwritten dividend reinvestment plans, thereby committing shareholders to an effective dilution in earnings per share.

However, rather than steering towards the majors, I would bet on Bank of Queensland and Wide Bay Australia to maintain their parochial local followings by sticking to a script of paying ever-increasing dividends, even at the expense of lifting the payout ratio. Bank of Queensland did precisely that recently, lifting its latest interim dividend by 3 cents to 35 cents per share, while maintaining a 74% payout ratio.

Similarly, with directors and management owning a fair chunk of the stock, Wide Bay Australia has a long record of lifting annual dividends. While the industry is now facing headwinds, Wide Bay’s branches are located in the fastest-growing state in the country, providing it with considerable protection and the opportunity to grow. 

James Carlisle

The trouble with a lot of high yielders is that high capital requirements make for fragile free cash flow, and low growth can leave the current level of dividends precarious for a long time. So a quality business with decent growth prospects can provide considerable comfort even if the payout ratio is high.

I toyed with ASX for exactly these reasons, despite its 90% payout ratio and somewhat volatile earnings. But in the end Harvey Norman came to my rescue, with its yield creeping above 4%. It has sound management, a strong balance sheet, a well covered payout and good prospects for building on that cover over the long term.

My other pick would be Westfield. Its distributions are barely covered at the moment, but development activity should soon provide a bit of breathing space.

Brad Newcombe

The obvious stock to me is Telstra. Over the past few years it has faced numerous challenges to its business model and operated with incompetent management (the previous, not the current regime), yet it has still managed to keep its dividend at 28 cents per share, fully franked. Telstra isn’t a high-growth company, but on a yield of 6.1% it doesn’t need to be.

My other pick isn’t a company but a whole sector, or specifically a sub-sector – the big four banks. While the banks have experienced ideal conditions over the past fifteen years they have also overcome numerous challenges. Even the blundering National Australia Bank, which blew up billions of dollars on various mishaps, has managed to maintain its dividend through tough times (admittedly through the use of an underwritten DRP). So even when the cycle turns, I’d expect the big banks at least to maintain their dividends.

Alex Chin

My first choice is Navitas, a provider of university and English language courses. The beauty of the business is the steady stream of cash and high profit margins. Students, needing a well-recognised qualification, are essentially locked in for the length of their course.

My other pick would be Coca-Cola Amatil. People still need to drink regardless of a downturn. As long as management doesn’t make stupid investments, the business should continue to produce profits. The issue is price. I’m not tempted to buy the stock at these levels.

The final word

As research director, I get to have the final say. Long-time readers and those who’ve been to our seminars will know that I’m very wary of the banks, as are a few other members of our team. But, as you can see from the responses, there are a couple of our analysts who believe the banks can continue to produce steady (or even rising) dividends in tougher times. I’m more sceptical.

My first selection is Westfield Group, for the reasons laid out by Gareth and the two Jameses. My second might be a bit more surprising, though. Acknowledging that we’re probably at the beginning of a nasty advertising downturn, I’m still prepared to nominate STW Communications. Profits could well fall, but there’s enough of a gap between earnings per share of 21.5 cents and dividends of 12 cents to offer a good degree of protection. And while management has said that dividends won’t be increased, I don’t expect them to be decreased.

I hope you’ve found this exercise useful. We enjoy this kind of brain teaser in the office and it’s nice to share our musings with you. It’ll be interesting to report back in a few years’ time to see how our selections have held up.

Dependable divvies

Stock (ASX code)	Selected by	Most recent review	Price ($)	DPS ($)	F’king level	Yield (%)
Bank of Queensland (BOQ)	Tony	30 Apr 08 (Avoid – $15.93)	14.30	0.72	Fully	5.03
Big four banks (ANZ, CBA, NAB, WBC)	Brad	Various (Hold)	Various	Various	Fully	Various
Bunnings Warehouse Property Trust (BWP)	Nathan	19 May 08 (Avoid – $1.94)	1.86	0.1311	Unfranked	7.05
Cabcharge (CAB)	Tim	20 Feb 08 (Hold – $9.81)	8.12	0.32	Fully	3.94
Coca-Cola Amatil (CCL)	Alex	15 Feb 06 (Coverage Ceased – $7.05)	7.66	0.355	Fully	4.63
Corporate Express (CXP)	Gareth	21 Feb 08 (Long Term Buy – $5.56)	6.10	0.265	Fully	4.34
Envestra (ENV)	Nathan	10 Apr 08 (Buy for Yield – $0.76)	0.73	0.095	Unfranked	13.01
Flight Centre (FLT)	Tim	26 Feb 08 (Hold – $28.51)	16.03	0.835	Fully	5.21
Harvey Norman (HVN)	James G, James C	14 Mar 08 (Long Term Buy – $3.63)	3.20	0.13	Fully	4.06
Macquarie Airports (MAP)	Steve	24 Apr 08 (Long Term Buy – $3.05)	2.60	0.26	Unfranked	10.00
Navitas (NVT)	Alex	Not covered	2.06	0.097	Fully	4.71
STW Comms (SGN)	Greg	15 Feb 08 (Long Term Buy – $2.24)	1.75	0.12	Fully	6.86
Telstra (TLS)	Steve, Brad	18 Apr 08 (Hold – $4.54)	4.56	0.28	Fully	6.14
Westfield Group (WDC)	Gareth, James G, James C, Greg	12 May 08 (Long Term Buy – $17.54)	16.65	1.065	Mostly unfranked	6.40
Wide Bay Australia (WBB)	Tony	Not covered	9.70	0.63	Fully	6.49

Disclosure: Staff members own many of the stocks mentioned in this article. For a full list, see the staff portfolio on the website or page two of the print edition.

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