Unsung heroes of the income investor

Woolworths, BHP, and Telstra have cut dividends in recent years, and the long-term sustainability of dividends from other leading stocks is under scrutiny. So Livewire asked three experts to share an example of a company that offers diversification away from ‘traditional’ income stocks - and provides a sustainable yield. Read on for responses.

Three reasons why we like Caltex for income

Neil Margolis, Merlon Capital Partners  

We recently established a position in Caltex, a leading Australian fuel refiner and distributor. To start with, the company has gradually shifted from a refining business to a fuel distribution and marketing business, as evidenced by the closure of its Kurnell oil refinery. This has reduced capital intensity and improved sustainable free cash flow.

The market has been concerned about the loss of the low-margin Woolworths wholesale supply contract following the planned sale of Woolworths service station sites to BP. However, this transaction further improves an already sound industry structure and we expect Caltex to replace these volumes at higher margin and reduce costs in the business.

Finally, the valuation appeal is further enhanced by more than $3 per share in surplus franking credits, which equates to around 10 percent of its current share price.

An non-traditional income stock

Jason Teh, Vertium Asset Management

Orora is one stock that is not considered a ‘traditional’ income stock. Given its earnings are relatively stable and its dividend payout ratio is set around 70%, Orora’s dividend is sustainable. Further, with 30% of its earnings retained and redeployed back into the business, the company has done an excellent job in creating shareholder value.

Three years ago, Orora’s return on funds employed was around 10% and now it is about 14%. With improving returns and a rising capital base, its earnings, and hence dividends, have increased by around 80% over the last three years.

Tech disruption may hit dividends in the long-term

Dr Don Hamson, Plato Investment Management

Technological change provides increasing uncertainty to almost any company in any industry; the internet, Airbnb, Amazon, Google, smartphones, and Uber are creating intense change/disruption.

For this reason, we think the notion of forever sustainable dividend yield at a single company may no longer possible, so the ability to monitor and avoid dividend traps is ever more important.  We think it is best to hold a diversified portfolio of yield stocks, rather than focus on a single stock. 

In the near term, however, we like the outlook for dividends at IAG, Woolworths and Wesfarmers, and even Fortescue which can now be considered a yield stock for as long as iron ore prices stay at current levels or higher and see those as being reasonable stocks to hold within a diversified income portfolio. 

Read next

In the first part of our equity income series, we heard the big-picture story of dividends on the ASX in 'The Dividend Dilemma'.

In part two, we asked our panelists on their take of Telstra’s future as an income stock, in ‘Telstra: dog or darling’?

Your say

You’ve heard from the experts, now we want to hear from you. Let us know in the comments below where you think investors can find sustainable income outside the traditional stocks.