It is often said that when the market takes a hit, that’s the best time to invest, and the COVID-19 pandemic is no different. Since the beginning of this pandemic, 2020 calendar year dividend expectations for the ASX 200 have fallen from ~$73bn to ~$58bn, which is broadly the same level of dividends that were paid in 2013.
However, we believe dividends will recover quickly, with 2022 underlying dividends expected to be broadly in-line with 2019 – this ignores special dividends that were paid ahead of Labor’s proposed franking policy changes.
Like any big change to the economy there are always going to be some winners and losers, but now is a key opportunity waiting to be seized by retirees and investors to invest in income generating equities.
Financials were hit hard with recession headwinds and regulatory intervention, whilst Resources companies have been faring well as high commodity prices help generate significant free cash. This is a good reminder for investors that sources of yield shift over time. Active portfolio management and stock selection can therefore have a significant impact on income generation.
All things considered; we expect income from equities will continue to be an important source of return for investors for several reasons.
First, the yield on equities is still very attractive relative to alternatives: The dividend yield for 2021 and 2022 is forecast to be 4-5% plus franking, compared to cash rates and fixed interest products below 1%.
Second, dividends will continue to be a large contributor to market returns, having contributed approximately half the ASX 200 index returns for decades.
Third, franking benefits are unique to the Australian market and provide a source of upside for domestic investors – particularly for retirees. Each year the portfolio typically receives dividends with ~78% franking attached.
Fourth, dividends have rebased with upside potential as revenues and dividend payout ratios normalise over the coming years.
We believe that a growing dollar income over time will deliver a positive outcome for income-seeking investors as they seek to offset inflation and look to maintain lifestyles into retirement.
Top four ASX stock picks
We like the following four companies that are high-quality businesses that offer a combination of attractive dividend income, growth, franking benefits and importantly, valuation support.
- IPH Limited (ASX: IPH): Provides intellectual property, patent and trade mark services across Australia, New Zealand and Asia. Its defensive characteristics, robust patent filing volumes and strong progress on the synergies from recent acquisitions were key highlights from reporting season. The stock is delivering a ~6% p.a. gross yield with high single digit growth and potential acquisitions should also serve as a catalyst.
- Atlas Arteria (ASX: ALX): Following a significant decline in traffic earlier in the year, traffic quickly rebounded on the main asset in France. Escalating COVID-19 case numbers and new lock-down restrictions in France have stalled the traffic recovery, however they are stabilizing 10-15% below pre-COVID-19 levels. This implies free cash flow of up to ~40cps, which translates into a dividend yield of ~6% p.a. at current prices.
- BHP Group (ASX: BHP): BHP offers ongoing earnings growth potential from its iron ore and copper exposure, with leverage to an eventual global economic recovery through coal and energy resources. In particular, iron ore prices continue to be robust given i) ongoing strong China demand, ii) Brazil supply constraints and iii) contracting economic output in world-ex China. Dividend yields of mid-single digits are supported by free cash flow yields in the high single and double digits over the next two to three years.
- Telstra Corporation (ASX: TLS): Telstra has not been immune from COVID-19 disruption with some negative one-off impacts from lower international roaming charges, customer incentives and delayed synergies hitting both FY20 and FY21 earnings. The market appears to have focused on the risk to the 16cps dividend from a lowering of near-term ROIC targets. In our view, the competitive environment in mobile is rational and will see improving earnings over the next few years. As such, we think the 16cps is sustainable, and represents an attractive gross yield of ~8% p.a. at current prices.
There is no ignoring we are in midst of a challenging period, and it will most likely continue well into the new year, but we believe ASX dividends remain very attractive, investors just be active and targeted.