Asia Unhedged sifts the global market for income opportunities, and finds that bargains are few. The most convincing are German and Swedish industrial companies with strong growth and stable market position, and Asian telecoms with a strong market position.
Income investors have been hating life. Long-term A-rated corporate bonds yield just 4%, or just 2% more than the expected long-term inflation rate. If inflation picks up or interest rates rise, moreover, the price of long-term corporate bonds will crash. 10-year US Treasury bonds pay just 2.2%, and German Bunds just 0.3%. High yield bonds pay less than 4% above the abysmally low Treasury yield, and are subject to default risk. Bond substitutes like utilities are expensive. US utilities trade at a price-earnings ratio of around 20 vs. a long-term average of 15. The S&P utility index pays a 3.3% dividend yield, but utility stocks trade like bonds when rates rise, and are risky with interest rates close to all-time lows.
The big bond funds have loaded up on emerging market junk debt to boost nominal yields, and their demand has pushed below-investment-grade corporate yields in emerging markets down to just 6% – not a lot of income for the attendant risk. And investment-grade emerging market corporates pay just 4%.
There are income vehicles offering huge yields, for example, the Master Limited Partnerships in the American energy space. But most of the MLP’s pay out more dividends than they earn profits, which means that they have to borrow the difference. A dividend payout ratio greater than 100% can’t be sustained. Most of them are highly levered, moreover. They are exposed not only to the oil price but to the cost of high-yield funding, and do not look seaworthy in stormy financial weather. A handful of them are managed conservatively and are worth considering, but they do not constitute a basket into which investors would want to put too great a proportion of their eggs.
Is there anything better out there for income investors with a long-term horizon? Dividends look more attractive than bond yields right now, but only in a select group of stocks. A company with long-term growth potential will increase its dividend over time, giving investors much higher income over time.
Asia Unhedged screened the global equity universe for stocks that met these criteria:
- An expected 2017 dividend yield of around 3%;
- Revenue growth of at least 10%;
- Return on equity of at least 10%;
- A dividend payout ratio no greater than 40%.
- Strong franchise businesses
- Ability to benefit from world trade growth.
There are some compelling opportunities, but none of them comes riskless. The German and Swedish stock indices yield around 3% with strong expected growth, but foreign investors have to take on currency risk. In the case of the Euro and the Swedish kroner, that risk well may be an advantage; the Euro is trading at the bottom of its historical range due to the European Central Bank’s ultra-loose monetary policy. That will be phased out during the next couple of years and the Euro is likely to appreciate.
Among German equities, look at VW, BASF, Bayer, Siemens and Continental AG. All have ADR’s that trade overseas. Germany takes a withholding tax for foreign dividends of 25%, but for US investors that is deductible against the 20% tax rate on dividend income.
In Sweden, the ball-bearing manufacturer SKF, automaker Volvo, and the mining and refining company Boliden are expected to pay dividends in excess of 3% this year.
Some Asian stocks with strong franchises are worth considering. The Hong Kong mobile phone firm PCCW and the Philippines’ Globe Telecom both offer dividends in excess of 5% and are well positioned in growth markets.
What about the US? The US market looks really, really expensive—no bargains here.
There are a small number of stocks that are expected to pay a dividend yield above 3% (according to the Bloomberg estimate, or BEst survey), and also have a reasonable dividend payout ratio and a high return on equity. There’s something wrong with most of them. A lot of them have high dividend yields because the stock price tanked. Some are highly specialized (solar energy, advertising, and so on). There are a couple of old favorites like Altria (MO) and Dow Chemical (Dow) worth considering. But who wants to buy GM just now, not to mention Wells Fargo, or Target?
For the more adventurous, there are high-yielders like Carlyle Group (CG), which yielded 8% over the past year, but is paying only 16% of its profits out as dividends. The publicly traded stocks of private equity firms are something of a black box, but in a rising market they generate cash flow with leverage.