Oliver Renton: How investors can find ‘Yield Royalty’ in Australia

How can investors find ‘Yield Royalty’ stocks that pay reliable dividends? Pendal Imputation Fund co-portfolio manager OLIVER RENTON explains

• Dividend certainty can support higher company valuations
• Franking credits encourage higher Australian payout ratios
• Find out about Pendal Imputation Fund

WHEN a company turns a profit, its managers and board have several important decisions to make. 

How much to retain on the balance sheet as cash or use to pay down debt?

What proportion to reinvest in the business?

How much should be returned to shareholders as dividends?

All of these choices tell us a lot about a company’s mindset and its confidence for the future.

But for investors chasing yield, it’s the dividend strategy that investors should pay particular attention to, especially:

• The dividend a company pays relative to its profit, known as the dividend payout ratio (DPR), and
• The dividend relative to the company’s share price, known as dividend yield, or just simply yield.

When comparing yield for various listed companies, investors might well ask: ‘Which are Australia’s reliable, dividend-paying “Yield Royalty” and how can I identify them?

Here is Pendal’s approach:

Yield Royalty

Investors looking for Yield Royalty may often think about the stocks that never (or hardly ever) cut their dividend. 

These companies have historically demonstrated relatively consistent dividend payments.

The ability to consistently pay reliable dividends is a signal that demand for a company’s products, its business model and capital structure are all resilient against fluctuations in various economic cycles.

For example, the oldest investor-owned public utility in the US, The York Water Company (NASDAQ: YORW), has provided a continuous dividend dating back to 1877. 

Consumer goods giant Procter and Gamble (NYSE: PG) has raised its dividend for 69 straight years.

Australian-listed companies have some impressive statistics also.  

There is some speculation that Westpac (previously Bank of New South Wales) may be the longest dividend-paying company in the world, dating back to 1800s.  

Washington H. Soul Pattinson has been listed since 1903 and paid a dividend every year since then. 

Hear more insights from Oliver:

A proud record

Australia can’t compete with other global markets in terms of sheer depth of listed companies, but we have a proud record when it comes to dividends. 

A nuance of the Australian market is “imputation”, which basically means getting a tax credit for company tax that has already been paid.

Australian companies naturally have higher payout ratios due to the tax advantages that accrue to domestic shareholders in the form of fully franked dividends. 

Thought higher payout ratios do mean there is less room for error against an economic cycle or some other event which temporarily stresses the business.

How to find Yield Royalty

So which Australian companies can be considered Yield Royalty and how do you identify them?

In an Australian context we define Yield Royalty as those companies that have not cut their dividend for five straight years, and only once in the past 10 years. 

This period includes the Covid-19 pandemic, which placed a lot of short-term pressure on many businesses.

Within the ASX100, these companies meet the criteria:

• Aristocrat [ALL]
• APA Group [APA]
• CAR Group [CAR]
• Charter Hall [CHC]
• Computershare [CPU]
• Medibank [MPL]
• Northern Star [NST]
• Pro Medicus [PME]
• Scentre [SCG]
• Steadfast Group [SDF]
• Sonic Healthcare [SHL]
• Washington H. Soul Pattinson and Company [SOL]
• Technology One [TNE]

It’s an interesting mix.

Many are clear leaders in their respective markets, though that’s not always the case. 

We would argue many of these take a sustainable, longer-term view as to how they run their respective businesses. 

These companies have strong dividend track records, but only a minority actually pay a yield greater than the broader market.

Being classed as Yield Royalty should reflect positively on a company’s rating and how it’s valued more generally.

Certainty or confidence about the forward prospects of a dividend stream, as guided by history, is inherently linked to a lower discount rate and a higher valuation.

Case study: Medibank

For the Pendal Imputation Fund we think about which companies might be considered Yield Royalty in the future.

We also consider which stocks may drop out of this basket – and the implications for how the market may perceive and value these companies as a result.

A stock in this basket that we do own in the Pendal Imputation Fund is health insurance provider Medibank [MPL].

Medibank has grown its dividend for six years in a row including nine of the past 10 years. 

Medibank has a forecast dividend payout ratio of 80 per cent and is forecast to pay out almost all its free cash flow in the form of dividends over the next couple of years. 

These payout ratios are quite full but supported by a conservative capital position which should provide buffer in more difficult times, should they arise. 

The short-tail nature of private health insurance means regulatory capital requirements are relatively low, certainly as compared to general insurers.  

In addition, return on tangible equity is high supporting this relatively full dividend payout ratio. 

Management and the board run a conservative and sustainable business, taking well-considered, long-term decisions. 

MPL has a strong track record of managing hospital partnerships and government relationships which stands them in good stead. 

The company handled Covid windfalls in a measured way, opting to deliberately return excesses to customers which built trust, brand and competitiveness. 

We think the conservative, sustainable way this company is managed – backed by historical delivery – warrants a premium rating.  

Medibank also has one of the healthier franking credit balances in the market and pays fully franked dividends.

Case study: Sonic Healthcare [SHL]. 

One stock we don’t own in the Yield Royalty basket is Sonic Healthcare [SHL]. 

SHL has a stated progressive dividend policy – it is paying a relatively high dividend yield of 5.5%, partially franked. 

Dividends increased by 4% pa in the five years leading up to Covid. 

SHL and other pathology operators did very well through the pandemic, which saw the company lift dividends by 7% in FY21 and 10% in FY22. 

The subsequent years have not been as kind. Margins have been squeezed by labour cost inflation on one side and tight government budgets on the other. 

Dividends have continued to increase against a backdrop of earnings that have fallen about 60% since FY22. 

This has resulted in the dividend payout ratio exceeding 100% in FY24 and FY25. 

The company also re-geared its balance sheet through M&A, such that it’s less prudent to fund dividend increases by taking on more debt. 

With speculated funding cuts in two of SHL’s largest markets in Germany and US – as well as persistently high labour cost pressures – there is a real prospect that earnings remain under pressure.

Ultimately the company may need to make the hard decision to walk away from its policy and cut its dividend.

 Yield Royalty and Pendal Imputation Fund

Pendal Imputation Fund has about 8 per cent of its portfolio in ‘Yield Royalty’.

This is a higher proportion than the broader market, but we remain selective in deciding who makes it in.

Yield Royalty is just one of the various ways Pendal Imputation Fund thinks about yield and how yield is expressed in the portfolio. 

Others include:

• Bond Proxies: stocks that have bond-like attributes and should therefore trade as such; preferred in a falling interest rate environment
• “Rock-Solid Dividends”: Stocks that give us confidence on their dividend prospects based on dividend history, capital position, cash flow generation profile, tight range of market estimates and high historical returns.
• Growth-At-the-Right-Yield: Stocks that give you favourable yield per unit of growth.
• Dividend Growers (DG): companies that might not have high yields today but impressive dividend growth track records that compound over time

In future articles we will delve further into these factors.

About Oliver Renton and the Pendal Imputation Fund

Oliver is an investment analyst and portfolio manager with Pendal’s equities team.

Starting his career with Pendal in 2004, Oliver has also worked with Pendal’s quantitative services, product and performance and attribution teams.

He holds a Bachelor of Commerce from the University of New South Wales, where he was awarded the Australian Institute of Banking and Finance Award in his penultimate year, and is a CFA Charter holder.

Pendal Imputation Fund is an actively managed portfolio of Australian shares which we believe will provide a higher yield than the market average.

Contact a Pendal key account manager