Seek good dividend value? Try Australian companies

Mr Baylis says that in many Australian industries, only a few companies provide for a large proportion of industry demand. As these companies have high economies of scale, returns on equity tend to be high.
Mr Baylis says that in many Australian industries, only a few companies provide for a large proportion of industry demand. As these companies have high economies of scale, returns on equity tend to be high.PHOTO: DIOS VINCOY JR FOR THE SUNDAY TIMES

Will Baylis, multi-strategy portfolio manager at Martin Currie, a wholly owned affiliate of Legg Mason, discusses his outlook for the Australian market with Jeremy Koh in the latest in our series featuring fund managers and leading market experts.

With interest rates down to zero or even at negative levels, investors are looking for stable, income-generating stocks and Australian companies might just be the answer, according to Mr Will Baylis.

Many firms Down Under have large market shares in their industries and high returns on equity that, in turn, mean they can afford high dividend payout ratios.

These dividends are sustainable due to the economies of scale and high barriers to entry these companies enjoy.

Q What is unique about Australian companies?

A My boss says Australia has unique animals and unique companies, because in many industries, only a few companies provide for a large proportion of industry demand.

The prices of consumer stocks are well lower than their historical highs and, because of that, they're a bargain. The dividend yield for the consumer stocks in Australia is expected to be about 6 per cent for the next 12 months based on current market prices.

Major companies in these industries have high economies of scale, and enjoy high barriers to entry.

As a result, returns on equity for these companies tend to be high.

They tend to distribute really large dividends, and they can do this because their return on equity is so high.

The average dividend payout ratio for the ASX 200 Index is around 75 per cent of earnings. This is expected to remain stable because of the high barriers to entry.

In certain sectors, return on invested capital is between 30 and 40 per cent.

Q How does the structure of Australian firms compare with that in the United States?

A We can compare the structure of Australia's companies to that of the United States.

For banks - the top three banks in Australia have 60 per cent of the market. In the US, the top three have 32 per cent.

If you look at personal and casualty insurance in Australia, the top three have 61 per cent of the market. In the US, it's 21 per cent.

If you look the equity market, the Australian Securities Exchange has 95 per cent of market share. In America, the largest exchange has 35 per cent.

The top three supermarkets in Australia command about 83 per cent of the market.

As for gas pipelines, there's a company called APA Group; it has 70 per cent of all pipelines in Australia. In the US, you have all these master limited partnerships, which have less than 10 per cent market share in their own right.

The Sydney airport has 26 per cent of all traffic into Australia. In the US, you're lucky to get 6 per cent.

Q How does the economic situation in Australia look, given the slowdown in the commodity sector?

A Australia does have significant resource exports, but exports should never be confused with GDP.

Resources as a sector have been no more than 10 to 15 per cent of GDP at any point in time over the last 15 years.

Non-mining GDP has been resilient even during the global financial crisis. It's been consistently growing at around 2 to 3 per cent, on average, in real terms from 2001 to now.

Australia is a diversified economy. There is no dominant sector in terms of its contribution to GDP, which is expected to grow at about 2.5 per cent this year.

Australia will have some of the fastest population growth globally between now and 2050, as it is looking to attract immigrants which are skilled and have high net worth.

The United Nations is predicting a 50.6 per cent lift in the population from now to then. So we're unlike, say, Japan or Germany, which have declining population growth.

Now that commodity prices have largely mean-reverted, the Australian dollar has weakened and adjusted back to its long-term average. This has been a big stimulus to the domestic economy. We're also getting very good employment growth.

Q Which sectors are you optimistic about?

A I'm optimistic on consumer discretionary and examples of that are owners of shopping centres and owners of supermarkets.

There are only a few major players for shopping centres. These firms don't build new supply until they know they can reach a 99 per cent occupancy rate.

As a result, there is a low likelihood of a spike in supply.

Owners of large shopping centres have rental agreements that are linked to inflation.

Population growth has also contributed to a steady rise in sales. Population growth will also boost shopping centre earnings and the dividends they distribute.

This sector will be supported by low interest rates, population growth, employment growth and GDP growth. About 60 per cent of GDP comes from consumption.

The prices of consumer stocks are well lower than their historical highs and, because of that, they're a bargain.

The dividend yield for the consumer stocks in Australia is expected to be about 6 per cent for the next 12 months based on current market prices.

Q Are you optimistic about any other sector?

A I'm optimistic on infrastructure and, in particular, on owners of toll roads.

Toll-road owners tend to run their toll roads to near full capacity, and this is not likely to change.

Transurban owns approximately 70 per cent of Australian toll roads. As it manages toll road expansion, the network is consistently fully utilised.

The earnings of toll road owners will be supported by population growth.

Most of these roads have annual inflation-linked toll rises, which is important if you're looking for dividends to be sustainable.

While utility and infrastructure stocks are trading at their highs, their dividend yields are attractive and there are good prospects for dividends to grow.

The dividend yield for the utilities and infrastructure sector in Australia is expected to be about 5 per cent for the next 12 months.

Q Would you invest in these sectors more for dividend yield than for growth in stock value?

A Yes, much more. We would buy companies on their sustainable dividend. We look at what dividend a company can pay at the low end of its business cycle and ask if they can pay that over next eight of the next 10 years.

A version of this article appeared in the print edition of The Sunday Times on February 28, 2016, with the headline 'Seek good dividend value? Try Australian companies'. Print Edition | Subscribe