Double-digit yields are on the horizon

Edited transcript

What we're seeing is probably one of the strongest we've ever seen. The decline in earnings last year, in the midst of the pandemic, saw earnings down about 25%, yet they've fully recovered, in aggregate, over the last 12 months. So, in terms of speed and size, that is the biggest, quickest recovery ever seen in the history of the ASX. This is quite remarkable and is led by economically sensitive sectors. We think that’s where we’ll see ongoing recovery and opening up, as the vaccines are rolled out and policy support is maintained. We think economically sensitive sectors are going to remain attractive and are where investors should be focusing their attention.

The big sectors in Australia, the banks and the miners have really led that. In fiscal 2021, at an aggregate level, they account for around half the profits of the ASX and they've enjoyed a very strong recovery. Which is, again, consistent with that economically sensitive theme. Those sectors are really leading the charge. And we think they will continue to do well.

And in the case of the miners: they’re really benefiting from very high commodity prices, which we think will stay structurally elevated for a period of time.

And across the board, we think the dividends are certainly returning because that earnings cycle is so strong. One of the key themes going into the pandemic was that the Australian corporate sector was quite lowly geared and that the banks were very well capitalised.

What does that mean? These companies were able to, in a broad sense, ride out the pandemic relatively well. They were well supported by the recovery in financial markets. Yes, there was some pain there in the short-term in terms of dividends being held back. But as the recovery has progressed, we think dividends, again, are definitely back on the scene. And particularly given that yields on term deposits have never been so low in Australia before, the attraction of dividends is further heightened going forward.

Traditionally, the banks are where investors have sought those dividends, they've been comfortable with the sustainability. That was in question last year when they really held back their dividends. But we think the recovery in dividends is going to be quite healthy and also more sustainable going forward. This is because the banks have been able to reset their payout ratios towards more sustainable levels, which we see as a positive.

A newer area where we think dividends will be quite attractive, albeit more volatile, is from the mining companies. They’re in quite a different position relative to any time in their history: their balance sheets are excellent, they're really not investing at the same levels that they used to, and their cash generation is sufficiently strong. This means they’re really just paying those excess profits out to shareholders. And we think that's not just a cyclical trend, but a structural trend where dividend rates will be much higher.

So, given where commodity prices are right now, BHP (ASX:BHP), Fortescue (ASX: FMG) and Rio Tinto (ASX:RIO) are likely to be on double-digit dividend yields over the next 12 months. And those dividends are fully franked. And if you look at it historically, the yield from those types of companies were relatively low around the twos or 3% sort of level, but they've now moved up sustainably into higher levels. It's probably more like five or 6%. And then when the prices are very high, they can go to these double digit levels and pay out those profits to shareholders.

In fact, over the next 12 months it looks like the aggregate dividends that BHP, Fortescue, and Rio pay just to ASX shareholders, so ignoring the foreign shareholders, ignoring people like Andrew Forrest, those dividends, just to those shareholders will exceed the dividends that the banks will pay to all of their shareholders on the ASX. So, it just gives you a sense of the quantum and therefore the attraction of high commodity prices and the ability to extract dividends for shareholders from that environment.

Well, there are companies that are starting to come through. Depending on where the opportunity is in the particular commodities. One commodity that's looking quite favourable, both cyclically and structurally, is copper. A company that's well-positioned in that space is OZ Minerals (ASX: MIN). That’s one of the leading copper exposures on the ASX.

It's very hard to find pure copper exposures around the world. And so this is one of them and they have a very attractive growth profile, which means the company is in a great position to bring growth in volumes on at a time when we really need those, particularly given the demands for electrification from trends like decarbonisation. It’s a company that's been around for a while, but one that is really establishing very strong growth credentials.

There are potential risks, but we think that they're relatively low as far as China goes with the commodity sector. And in fact, China's influence on the commodity sector, we think, is going to be much more positive than negative because of the demand growth and the size of the Chinese economy. That's an ongoing theme for commodities that will continue.

The biggest commodity that people will focus on as a potential risk would be iron ore because of the sheer size of it for Australia as an export to China. But we tend to think that that risk is not a very high one in terms of disrupting that trade. And it's really because China's steel industry doesn't have alternative sources of supply. And although they may strategically look to develop alternative sources of supply, it will take them a very long time to do that.

Certainly over the next five, maybe 10 years, it would take a long time for China to diversify away from Australia in terms of its iron or supply. And so the alternatives for China to disrupt its steel industry by, in a sense, exacting some type of punishment on Australian iron ore, is a very high price for both parties to pay, and we don't think it's very likely to happen.

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