Five Dividend Stocks Set to

Thrive in the Post-Pandemic Era

2

Five Dividend Stocks Set to Thrive in the Post-Pandemic Era

By Greg Canavan, Editor, The Rum Rebellion

Could the cash rate in Australia actually go negative?

Up until recently, that question wasn’t even on investors’ minds. However, with a string of rate cuts taking the cash rate to a paltry 0.25%, negative rates could be something we all have to grapple with in the future.

It almost seems impossible to comprehend. Fancy paying your bank interest just to deposit your funds. Or, earning interest when you take out a loan.

The concept flips the whole concept of money on its head.

Interest rates are supposed to be the barometer for risk. The higher the risk, the higher rate a lender will charge. If negative rates ever do come to fruition, this basic premise of finance flies out the window.

The real question is though, what would you do if rates did go to zero? Or more to the point, if they went negative. If that were the case, how would you invest your funds to generate sufficient income to live, let alone pay the bills?

One thing looks certain, power bills and other expenses aren’t heading down. With wages barely tracking inflation, and expenses rising, households are becoming evermore squeezed as they strive to make ends meet.

It also means that those who might have invested in cash products, like term deposits, will likely need to find other asset classes to invest their money. That could mean putting more money into shares than they might wish to.

If you look at many of the income portfolios put out by the brokers, they will likely include the same old stocks, including banks. While banks have been steady and reliable dividend payers for years, they have never been under more pressure.

3

Banks too are victim to low interest rates. For them, it makes it more difficult to maintain their once healthy margins. Plus, there is also a possibility that their overseer, APRA, might require them to raise even more capital in the future.

For their millions of shareholders, that means bank dividends may have peaked for the foreseeable future.

Don’t get me wrong. I’m not saying you shouldn’t own some of these old income favourites. These mega-cap stocks will still likely play a part for many income investors.

What you also need to consider, is the other dividend-paying stocks out there. There are literally hundreds of other dividend paying stocks on the ASX to choose from.

And with the massive, and still unfolding, impact of the coronavirus wreaking havoc, many are trading at a fraction of their long-term value.

Today, I’d like to show you some dividend stock ideas for 2020 that are not on everyone’s radar…and not one of them is a bank.

Of course, these are just ideas I am giving you. It is up to you to research them and see if they suit your personal needs. If in any doubt, please be sure to speak to a financial advisor who can help decide if these stocks are for you.

Even if you don’t think any of these stocks fit your needs, I hope this report at least sparks an interest in you to research some other dividend payers on the market.

So please keep reading for what I consider to be among the five best dividend-paying stocks on the ASX…

Dividend stock # 1 — One of many solutions

The first stock on the list would not have made it into the top five a few years ago. Not because its yield was substandard, but because it didn’t offer any yield at all!

Once one of the bluer of the blue chips, this company was a staple of many investment portfolios. However, a series of events put it through the ringer — some of its own making, and some purely bad timing.

The company I am referring to is energy behemoth, Origin Energy Ltd [ASX:ORG].

Origin’s activities cover the full gamut of the energy sector, from oil and gas exploration and production, though to gas and renewable power generation. Origin is also a retailer, boasting over four million customers.

As a vital utility, Origin’s future always seemed assured…and predictable. However, a game-changing investment in the massive LNG gas project, Australia Pacific LNG plant (APLNG) came just as the oil price headed south.

While Origins debts ratcheted skywards, the price of oil (from which gas prices are closely derived) fell through the floor. It was a full double whammy. So much so that

4

Origin had to go to the market to raise around $2.5 billion in capital.

Meanwhile, it got to work ripping costs out of its business. With a series of write-downs, Origin posted losses and had to cut its dividend.

All that changed, as oil prices recovered throughout 2015 to 2017 and Origin paid down debt, enabling Origin to reintroduce its dividend.

Fast forward to today, and the oil price is once again under massive pressure. Already some of the oil shale producers in the US are heading out the back door.

Coming on top of the coronavirus, that means Origin is also feeling the pinch. Having traded into Christmas 2019 heading towards $9, its share price briefly traded below $4 in March 2020.

While much is made about the transfer to renewable energies, energy companies the world over have the much harder task of actually delivering a reliable service. As we have seen in Australia, higher costs with less reliability makes electricity a hot political topic.

Origin’s 37.5% stake in the APLNG project is paying dividends…literally. As operator of the plant — as well as a shareholder — Origin gets an extra cut of the huge revenue on offer.

For APLNG’s clients, including its joint venture partner in APLNG, China’s Sinopec with a 25% holding, reliable gas supplies are imperative so that they can deliver power to their customers. Because of that, energy companies want to lock away long-term deals from their suppliers.

With the construction part now well behind it, money is flowing in from APLNG, rather than the other way round.

Of course, the great uncertainty are the long-term impacts from the coronavirus pandemic and slump in oil prices.

Only last year, APLNG were forecasting demand for LNG in Asia to grow at a compound average of 7.7% per year. For the time being at least, that forecast remains too uncertain to gauge.

However, if you believe that the coronavirus will pass and the global economy will wind itself back into gear, now could be the time to consider Origin for an income portfolio.

Investing in Origin is not without its risks. These included, but are not limited to:

• A continued fall in the oil price, leading to a lower gas price for APLNG

• The coronavirus ripping a bigger hole in the global economy than current predictions

• A continued fall in the global economy, particularly Asia, leading to a lower demand

• On the home front, any changes in government and/or legislation could put a cap (or tighten the cap) on the amount Origin can charge its customers, thereby

5

limiting profits

• Competition: not just from emerging technologies, but from global players like Shell moving into its space

As its share price rallied last year, Origin traded on a yield of just over 3%. Now with the share price around $4.25, Origin trades on a much higher fully-franked yield of 6.3%.

However, it may become increasingly difficult for Origin to maintain the current size of its dividends, as the true impact of the coronavirus is far from clear.

Origin’s policy is to pay between 30–50% of free cash flow out in dividends, giving it more flexibility than other stocks on the ASX. A significant reduction in group debt should also help Origin in any recovery.

What’s more, with the size of its footprint in Australia, Origin could come onto the radar of global energy players looking to find an entry into the Australian market.

Dividend stock # 2 — From soft drinks to planes and cars

Resource companies aren’t always the best companies for yield hungry investors. They are at the behest of global commodity prices — something over which they can exert little (or no) control.

These type of companies are also up against the old supply-demand curve. As demand increases pushing prices higher, producers will typically dial up their supply to make the most of higher prices. In doing so, creating an oversupply, which can force prices back down again.

It can be a tough ask for management to manage this cash flow over the economic cycle. Those resource companies that operate in the lowest cost quartile have a bit more buffer when prices turn south.

The next pick on the list is a resource company which operates in this lowest cost quartile in its industry. It is bauxite miner and alumina refiner, Alumina Ltd [ASX:AWC].

AWC is the joint owner with Alcoa Inc. of AWAC — Alcoa World Alumina and Chemicals. Alumina (Australia) owns 40%, and Alcoa Inc. (of the USA) the other 60%. AWAC owns bauxite mines in five countries, which is refined to make alumina — the product used to make aluminium.

Bauxite is refined into alumina, which is then smeltered into aluminium. Very roughly, you need two tonnes of alumina to produce one tonne of aluminium.

As you know, aluminium is used for a multitude of tasks. From soft drink cans, boats and cars, through to aeroplane parts.

AWAC operate seven alumina refineries, three of which are in Western Australia, with others in the US, Guinea, Brazil, and Spain. Its one aluminium smelter is located in Portland, Victoria.

6

As part of its joint ownership deal, Alumina receives quarterly distributions from AWAC. If available, after paying any debt commitments (net debt target is $120–130 million), and any other corporate costs, Alumina shares this with investors via dividends.

As I say, commodity prices can swing around a lot. And alumina is no different. Apart from operating in the lowest cost quartile, Alumina has other advantages.

Once a key supplier to the market, China’s stockpiles continue to dwindle. The largest producer a decade ago, China has closed inefficient operations, and put caps on new capacity.

This drop in supply from China also has to do with air quality. More specifically, China’s goal to reduce pollution. This can lead to a complete shutdown in winter, as pollutants caught in denser air find it hard to escape.

After enjoying a stellar 2018, alumina prices fell back to Earth in 2019. And this year — even before the true scale of the coronavirus became evident — the price of alumina remained under pressure.

So why would a stock like Alumina be on anyone’s radar?

Again, it comes back to what I mentioned earlier. That is, that commodities move in cycles.

As the price of Alumina falls, it forces less competitive suppliers out of the market. As return on investment (ROI) also falls, it delays the creation of new, or expansion of existing, projects. And this is what causes the cycle to start over.

As a producer with significant scale, operating in the lowest cost quartile, AWC has business economics on its side to survive while its less efficient competitors dramatically cut production, or close their operations entirely.

As I say, investing in Alumina is not without its risks. Some of the key risks include:

• Spot price — although Alumina is one of the lowest cost producers, it’s still reliant on the price of alumina. A fall could lead to less profits (or a loss), reducing the payments Alumina receives from AWAC.

• Global economy — aluminium is a key component in goods, from cars and planes to aluminium foil. Weakening global demand — as we are seeing with the coronavirus — will reduce the demand for alumina, thereby reducing AWC’s profitability.

• Trade war/political — it has been a bumpy ride in relations between China and the US in the past few years. Just as a truce looks certain, a trade war can flare up at any time again. Add in the trading of barbs between the two countries over the coronavirus, relations are decidedly frosty. It is unclear what the impact might be for alumina (and other resource companies) if hostilities escalate.

• Costs — a jump in wages and/or cost of production, could also lead to lower profitability.

Last year, AWC was trading on a fully-franked yield of almost 10%. However, as I mentioned, this yield is not always sustainable. Back in 2013–14 when excess supply saw

7

the alumina price tank, Alumina did not pay a dividend at all.

Today, with a recent price of $1.46, AWC trades on a current fully-franked yield of 6.8%.

If you decide to invest in Alumina, you need to keep one eye on the spot price of alumina (the commodity). Plus, another eye on the exchange rate. As AWC receives distributions from AWAC in US dollars, any increase in the Aussie dollar against the USD will lower this distribution…and vice versa.

As one of the more predictable commodities, and given its industry low cost of production, AWC is one stock to consider for a yield investor.

Dividend stock # 3 — An irreplaceable asset

As the markets ticked over into 2020, fair to say, fair value was thin on the ground. Investors all over the globe had bid up stock prices as the decade-long bull market showed no signs of abating.

That was until mid-February, when the bottom dropped out of the market. Having first been seen as just another bump, coronavirus fears gripped the market, sending it into total freefall.

No stock survives a sell-off like that — both good and bad stocks got hammered daily, including your next stock. Though in this case — in my view at least — this stock certainly fits into the former grouping.

The stock I am referring to is Sydney Airport Holdings Pty Ltd [ASX:SYD]. Given its sheer size and scale, and close proximity to the CBD and Eastern suburbs, trying to replicate SYD would be impossible.

For as long as I can remember, SYD has traded with a huge price/earnings (P/E) ratio. Often at 55 or higher. At times, it seemed as though SYD was priced more like a high-tech growth stock.

With the dramatic falls we have seen with the coronavirus, SYD too has come back to Earth. Coming into Christmas last year, SYD was trading at over $9.

By March this year, it was testing $4.40. That’s a dramatic fall for one of the most irreplaceable assets in the country. What’s more, its once hefty P/E has halved, though still trades at a significant premium to the P/E of the market (as it always has).

Of course, the big question with SYD is how the coronavirus pandemic pans out. More specifically for SYD, if and when, travel gets back to normal.

When things turn around — and turn around they will — Sydney Airport will remain the primary entry point into Australia. In 2019, Sydney Airport reported 44.4 million passengers pass through its doors.

Earnings before interest, tax, depreciation and amortisation (EBITDA) increased 4% in 2019, to $1.34 billion. Though clearly, the coronavirus will put a huge dent in this year’s

8

numbers. Meaning Sydney’s current 5.4% yield will likely be unsustainable this year.

As with all investments, there are risks to investing in SYD. These include, but are not limited, to:

• Coronavirus — this is the great unknown. Until there is more certainty about how this pans out, the number of passengers travelling through SYD will be subdued.

• Recovery — the other side of this is the speed of the recovery. When things get back to normal, it will take some time for momentum to build back up. That is, for people to get back into the habit of travel. For those who used to travel for business, they might find that they adapt and fly less often in the future.

• International — a big part of SYD’s revenue comes from international travellers. Not just tourism, but for education — both school and university. Any travel restrictions from foreign governments, or a change in study or tourism destinations would also put a dent in SYD’s revenues.

• Management — SYD’s management has made good use of its assets, growing passenger numbers and profits over decades. Any misplaced capital investments could see debt rise, without a corresponding uptick in revenues.

As I say, the great unknowns are how long the virus will last, and when travel will get back to normal. But when things do return to normal, SYD should retain its place as the busiest travel hub in Australia, enabling it to pay out a string of dividends to its investors.

Dividend stock # 4 — How to take some volatility out of your investments…and beat term deposits

For some, the idea of investing in cash or fixed interest (like a bond) might not be the most exciting way to earn income from the market. Let’s be honest, it might even sound a bit dull.

However, investing some of your funds into cash and/or fixed interest investments can add two important qualities to your portfolio.

First, it can lower volatility. When the market is swinging wildly — up one day and down the next — a fixed interest investment can reduce the big swings across a portfolio.

And second, it should pay regular income, even when the stock market takes a tumble.

That is where your next pick comes in. The next stock on our list is an exchange-traded fund (ETF), so, technically, it’s not really a stock. However, it is listed on the ASX, so you can readily buy or sell units in it, as you would with any other shares.

It’s called the Vanguard Australian Fixed Interest ETF [ASX:VAF], and it pays distributions to its investors quarterly. VAF is currently trading on an unfranked yield of around 2.5%.

Yes, I know. That might not be enough to get you excited. And franking credits would

9

also be handy.

However, that’s the trade-off for having less volatility. After all, you won’t find a cash trust, term deposit or similar investment that pays franked distributions either.

In saying that, the distribution from VAF is higher — and sometimes more than double most term deposits. Plus, you receive distributions quarterly.

Right now, you’ll be lucky to get much over 1% on a term deposit with one of the Big Four banks. Many actually pay below 1%. What’s more, you will have to lock your money in anywhere from three to 12 months.

The advantage of VAF is that unlike a term deposit, you aren’t locked in. You can offload your units as you would with any other stock listed on the ASX.

So what does VAF do?

VAF invests in high quality government bonds issued by the Commonwealth Government of Australia, along with those issued by the various state governments. All up, nearly 90% of the fund’s assets are invested between these two groups, with the remaining 10% or so, invested in high-rated corporate bonds.

Ratings agency Standard & Poor’s assign an investment grade to different types of securities. The highest investment rating is AAA, with the lowest being the speculative grade D. Around 75% of the holdings in VAF’s portfolio are rated AAA, with another 20% rated AA — one grade below the highest.

All up, VAF holds close to 93.6% of funds in these two highest grades — AAA or AA, with the remaining 3.7% invested in grade A 2.7% in BBB. These investments are spread around approximately 600 holdings from around 185 different issuers.

When the stock market is booming, and it seems like just about every share is going up, investing in fixed interest might dampen your overall returns for a while. You might wish for something with a higher return.

But it’s for the other times that you invest in something like VAF. While you might get some capital growth, your primary aim with VAF is to invest in an ETF offering a regular income with lower volatility.

There are risks, as there are with all investments. These include, but are not limited, to:

• Risk of default — although VAF invests in the highest investment grade bonds available, bond issuers can still default, whether they are a government body, or a corporation.

• Inflation — rising inflation can whittle away the value of VAF’s distributions.

• Duration — this measures the sensitivity of a bond value in relation to a change in interest rates. As interest rates increase, the value of a bond decreases. That’s because an investor can get a higher interest rate elsewhere. If VAF gets this duration mix wrong, it could lead to sub-standard returns.

10

• Underperformance — as I say, the idea behind a pick like VAF is to keep generating income, whilst helping to reduce volatility in a holding of stocks. However, in a long-term bull market, holding an ETF like VAF could lead to a lower overall return, as there are higher returning stocks elsewhere.

However, to help reduce volatility, along with maintaining regular (quarterly) income, VAF is one to consider. While you will find stocks paying a high yield, VAF’s distributions easily exceed those returns available on term deposits.

Dividend stock # 5 — It’s all about interest rates

With global interest rates at near zero — and negative in some parts of the world — the hunt for yield has never been on in more earnest. Especially for those relying on their savings and investments to supplement their income.

Sure enough, if you own a house, you’re likely to be sitting on a very valuable asset. But that’s not to say that you won’t be cash-poor. It almost seems incongruous that despite owning a house that could be worth in the millions, you might barely have enough cash to pay the rates.

Until interest rates go up, which seems more unlikely every day, investors will need to find alternative ways to generate income.

Only a couple of years ago, the sector in which your next pick operates was out of favour. With the Federal Reserve in the US tightening rates, yield hungry investors started pulling their money out of the sector and investing it elsewhere.

In the massive sell-off we have seen with the coronavirus, this sector has not been immune. It has fallen as far, if not further, than other sectors on the market.

The sector I am talking about here is the real estate market. Or to be precise, A-REITs (Australian Real Estate Investment Trusts).

Some investors tend to think about property as a single grouping. And in some ways, they are right. Across the board, interest rates play an important part in how all property is valued.

Private property investors tend to focus on the residential market. After all, they are typically a homeowner themselves. It is a market in which they already have a foothold…and an understanding.

If you are a bit more well-heeled, you might even own some commercial property. Things like shops, or commercial premises in an industrial estate, for example.

Where REITs can be a handy tool, apart from their yield, is the vast array of property you can invest in. From residential bulk builders, to toll roads, high rise offices, supermarkets, and shopping malls.

What’s more, you don’t have to take out a giant sized mortgage to get involved. Instead, you can start with a mere fraction of that.

11

And that is where your next pick fits into the picture. It is an A-REIT, Centuria Industrial REIT [ASX:CIP], that specialises in just one section of the property market: the industrial sector.

All up, CIP owns 48 industrial properties at time of writing, with a current value of $1.6 billion. While that might sound like a pretty decent size, that makes CIP a minnow compared to some of the much bigger REITs in the market. So please keep that in mind if you decide to invest.

As I say, CIP invests solely in the industrial sector. Its gross lettable area across its 45 properties is just over 855,000 square metres.

Its purchase in September 2019 of Edinburgh Park, SA, is typical of the type of sites that CIP owns. CIP paid $19.5 million for the 6.5 hectare site, which is 100% occupied with an average lease expiry of 10 years.

The initial yield of the Edinburgh Park site is 7%. Across its $268 million of acquisitions throughout 2019, CIP state an average yield of 7.6%.

The vast bulk of CIP’s properties are located on the eastern seaboard, in NSW (38%), Victoria (25%) and Queensland (21%). The remaining properties are located in Western Australia (14%), with just 1% each in both the ACT and South Australia.

CIP’s largest tenants at 29%, are transport and logistics businesses. Consumer staple and manufacturing make up another 20% apiece, with consumer durables at 10% and consumer discretionary at 6%.

The remaining 15% are held by a mix of tenants, from health and pharmaceutical, to construction and Food and beverage.

In terms of tenant income, 23% comes from ASX listed companies, and 7% from listed multinationals. Multinational and national domestic companies represent 12% and 21% of tenant income respectively, with just over a third coming from other tenants.

There are risks to investing in CIP as there are with all investments. These include, but are not limited, to:

• Economy — a slowdown could see lower occupancy rates, and/or leases negotiated at less favourable terms for CIP.

• Interest rates — if interest rates rise, this could lead to a lower valuation of CIP’s properties, forcing them to downgrade profits.

• Management — the strength of a REIT is the quality of the properties it owns. If CIP were to acquire some substandard sites, or pay too much for a site, this could lead to potential lower returns and valuations.

• With a market cap of less than $1 billion, CIP is smaller than some of the larger REITs on the market. Given its size, it could potentially decide to undertake a capital raising to finance further acquisitions rather than take on more debt, which

12

could dilute your holdings.

CIP currently trades on an unfranked yield of 8.1%. That’s around six to eight times more than what you will currently generate from a term deposit.

But don’t forget there are risks involved. Tenants impacted from the coronavirus may be unable to meet their full rent commitments — and property valuations can also go down.

Please remember…

I certainly hope you find some of these ideas helpful. However, these are not official recommendations, so always do your own research before making an investment. Remember, a good stock can perform poorly in a falling market. Always be vigilant, and be prepared to exit a stock if circumstances change.

Regards,

Greg Canavan, The Rum Rebellion

13

All content is © 2005–2020 Port Phillip Publishing Pty Ltd All Rights Reserved

Port Phillip Publishing Pty Ltd holds an Australian Financial Services Licence: 323 988. | ACN: 117 765 009 ABN: 33 117 765 009

All advice is general advice and has not taken into account your personal circumstances.

Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

Calculating Your Future Returns: The value of any investment and the income derived from it can go down as well as up. Never invest more than you can afford to lose and keep in mind the ultimate risk is that you can lose whatever you’ve invested. While useful for detecting patterns, the past is not a guide to future performance. Some figures contained in this report are forecasts and may not be a reliable indicator of future results. Any potential gains in this letter do not include taxes, brokerage commissions, or associated fees. Please seek independent financial advice regarding your particular situation. Investments in foreign

companies involve risk and may not be suitable for all investors. Specifically, changes in the rates of exchange between currencies may cause a divergence between your nominal gain and your currency-converted gain, making it possible to lose money once your total return is adjusted for currency. The Reader acknowledges that the contents of this newsletter and all associated intellectual property rights of Port Phillip

Publishing Pty Ltd (PPP) including copyright, design rights, property rights, rights to data and databases, trademarks, service marks and any other rights created or developed in the course of the provision of the newsletter shall be and remain the sole and exclusive property of PPP. No person is permitted to copy, forward or reproduce the newsletter and/or its contents without express consent of PPP. Subscribers to the

newsletter are permitted to use this material for their own personal and investment use.

If you would like to contact us about your subscription please call us on 1300 667 481 or email us at cs@portphillippublishing.com.au

Port Phillip Publishing Attn: The Rum Rebellion 96/98 Bridport St, Albert Park VIC 3206 | Tel: 1300 667 481