With interest rates still low, investors remain on the search for other sources of income to increase returns. Up until recently, investors have been able to source good levels of income from high yielding infrastructure and property stocks along with your traditional high yielding blue chip stocks.
However rising long term government bond yields bring the potential for capital loss if you are looking to buy infrastructure and property stocks at this point in the cycle. We have also seen some of the traditional blue chip companies such as Telstra and Woolworths cut their dividends leading to falling share prices. We see it becoming increasingly difficult to source income stocks at this point in the cycle without the risk of falling capital values.
The reason Australian long term government bond yields are rising despite short term interest rates’ remaining low is due to rising interest rates and long term government yields in the US. You might still ask what has that got to do with Australia? Australian long term government bond yields are heavily correlated to US long term government bond yields.
As bond yields (considered risk free assets) rise, so too will the yield of other asset classes as investors will always require a premium return on these assets relative to bond yields given the increase risk of these asset relative to government bonds.
Post reporting season, we see Suncorp (SUN) as being reasonably valued with a sustainable dividend yield.
It’s important to remember if considering an investment in Suncorp shares, that it is more of an insurance company these days as opposed to a bank, given that more than 70% of profits come from its insurance divisions.
While Suncorp’s recent result disappointed relative to high market expectations, given higher claims affecting the company’s New Zealand business and also a softer banking result due to higher costs, we think the stock represents good buying for income based portfolio at present, offering a 6.00 per cent fully franked dividend yield in financial year 2018, giving you a grossed up yield of 8.50pc.
We also have confidence in Suncorp's ability to maintain its dividend given it had $350m of excess capital (above regulatory requirements) at the end of financial year 2017.
We also think the eventual move to Basel III advanced accreditation by Suncorp’s bank should release some capital, albeit slowly, providing further support for the company’s dividend payout ratio.
Finally any life insurance business sale, potentially in 2018, could also see some additional capital released for distribution to shareholders.
- Justin Still, Investment Adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410.
