Can dividends be sustained under Delta?

They are officially back. The August reporting season re-opened the treasure chest of dividends, but are they destined to stay? Banks have announced record buybacks, and mining companies rewarded shareholders handsomely on the back of high commodity prices and capital discipline. 

The one stain on these prospects continuing? Good ol' Delta. But the strength of Australia's economic activity may mean these concerns are overblown in the long run.

"Generally speaking, it (Delta) won't be significant for the profit cycle or for dividends...The important thing to note is that Australian corporates are in very strong financial health...That allows companies to look through the disruptions we are seeing."

Mike Jenneke from Credit Suisse Private Banking is very aware of the risks to this thesis, such as reduced vaccine efficacy or a constrained reopening. In this Expert Insights, he sat down with Livewire's Mia Kwok to discuss the key takeaways from reporting season from a dividend perspective, his outlook on the implications of Delta, plus Jenneke shared some quality dividend names in the market today.  

Transcript edited for clarity

We've just had a really strong reporting season. What have you gleaned from the dividend payouts of the big four banks?

The Australian banks are in a very strong position in terms of their capital positions, so from a dividend perspective - given that they've rebased these dividends and structured them around more sustainable paths - the prospects for sustainable dividends and growth from these levels is pretty good. The capital positions are exceptionally strong and they're returning some of that excess capital through buybacks that will reduce the share count. That will therefore lead to some growth in dividends as well. So the combination of that with economic recovery sets the banks up reasonably well to grow dividends from these levels.

How did the mining companies deliver this reporting season? What's the future growth trajectory in that sector?

Mining results were exceptionally strong. The cash flows that were generated by the companies were at record levels and that reflects the combination of high commodity prices, but importantly, capital discipline. That's a real change from what we've seen in the past. 

The companies are far more reluctant to invest aggressively on the back of those high prices, so volumes are not growing significantly, and they are then returning that excess cash prize to shareholders. That capital discipline sets these companies up well to continue to pay attractive returns through the cycle. 

Albeit acknowledging that prices are higher, payouts will be volatile and that at normalised levels, payouts will be lower than they are today. Nevertheless, they will be attractive even at those levels.

A lot of the dividend payouts we're looking at now are off the back of a recovery play in the early half of 2021. What are the effects of Delta and continuous lockdowns in Australia on dividends?

We think that generally speaking, it won't be significant for the profit cycle or for dividends. Delta is causing some short-term disruption. But the important thing to note is that the corporate sector in Australia is in very strong financial health. 

Balance sheets are the strongest they've been in history, and that allows companies to be able to look through the disruptions that we're seeing. So as long as the Delta does not derail the economic recovery - and we're not expecting that - companies can look through the disruption and continue to pay out attractive dividend levels. 

The banks are a good example of this process already. There have been downgrades to economic growth. There were concerns that perhaps the return of excess capital would be delayed and that has not been the case because they've been in a strong enough position to be able to look through that short term disruption.

What are some of the opportunities in the market at the moment? What are some stocks or sectors that you're looking at right now?

We continue to have a bias in our portfolios towards the more economically sensitive sectors. We see some more attractive valuations there, and they're well-positioned for the reopening and recovery that we're expecting. Within a well-diversified portfolio, where we tend to earn the majority of that dividend income is from the banks, but also from the big mining companies. And we should put in context, mining company dividends are attractive but also volatile and likely to be lower in the long term than they are today. Nevertheless, within a diversified portfolio, they are providing us with attractive returns and we have spread our risks in other sectors to be able to counter some of that volatility.

Another interesting company that's somewhat linked to the mining sector, but is lower risk and is paying very attractive dividends is a company like Aurizon (ASX:AZJ). Aurizon provides rail infrastructure to the coal industry predominantly but is also starting to grow into other commodities. The concerns around coal have led to a very significant overreaction in the share price. The company is actually a very low-risk infrastructure provider that despite facing very long-term headwinds, will pay attractive dividends for many years to come. So from my point of view, that's an interesting diversification from some of the traditional sectors.

What's an example of a stock in the mining sector and providing those sustainable dividends?

An interesting stock in the mining sector that has been repositioned is South32 (ASX:S32). They've divested their thermal coal assets in South Africa, which is positive and importantly they have significant exposure to aluminium. Aluminium is starting to look more prospective  than it has for a long period of time. There are more constraints on production growth, there are benefits from being involved in de-carbonization, and South32 is positioned for that. They also have other base metal assets, which are benefiting from strong commodity prices. The balance sheet is in exceptional shape and they are returning cash to shareholders, both through dividends and buybacks. The company has performed reasonably well so far to date but remains undervalued and we think it will continue to do well going forward.

Looking ahead to the next 6-12 months, what is your outlook for sustainable dividends?

Our outlook continues to be positive in relation to dividends. We're expecting to see the consensus is for double-digit earnings growth over the next 12 months as the recovery continues. It's quite broad-based as well, as we really saw through reporting season, there was a wide recovery. There was a positive reaction to that and we're expecting to see that dividend growth given the balance sheet strength of the corporate sector will tend to follow those trends. In aggregate, we're expecting around a hundred billion dollars of dividends and capital returns over the next five months, so there'll be a lot of cash coming into the market. 

It is still attractively priced, and there's limited risk at this point in time, given the attractive easy policy settings that are in place and the progress we're making with the vaccine rollout.

Will there be any speed bumps in that growth runway or any risk factors that you're looking out for?

The main risk factors that we're looking out for are the potential for vaccine efficacy to drop off and perhaps a reopening that is more constrained than we're hoping with the success that we've seen so far. That's one area to monitor. We are also seeing a somewhat slower pace of growth in China as well and there have been some changes in the regulatory regime, which have caught investors a bit off guard. Again, we just need to monitor the impact that has on the Chinese economy. 

Broadly speaking, we remain very confident in the growth of the Chinese economy, but there are some higher risks there in the near term. We're not expecting to see significant speed bumps. 

There's always the risk of a correction in markets because they've done very well and valuations are more stretched. There's always that potential risk that we see a sell-off because of some adverse news, maybe a peaking in earning cycle in the near term, for example. But overall, we would see those corrections as buying opportunities.

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