The search for yield continues

Financial Article 424 by Edward Rizzo - Mar 03, 2016

Last Thursday afternoon the Treasury of Malta issued a press release informing market practitioners that subscriptions from the General Public for the two Malta Government Stock (MGS) issues exceeded €200 million and therefore the tendering process for institutional investors was being cancelled. This may have surprised many market followers especially since in the last MGS issue in October 2015, the General Public ‘only’ applied for €88.2 million.

The full details on the recent MGS offerings have not been published as yet. However, the statistics should amply indicate that the 20-year issue was the far more popular one by retail investors given the unattractive terms of the 6-year bond.

While few may have expected the entire amount to be allotted to members of the General Public thus crowding out institutions, this clearly indicates the continued search for yield by retail investors.

I recall that just over one year ago, I had written an article “The Search for Yield” in which I had explained that following the decline in Eurozone interest rates in Summer 2014 and the announcement of the Quantitative Easing (QE) programme by the European Central Bank (ECB) in January 2015, investors were turning to the equity market to obtain a better yield when compared to the declining returns across the bond market.

Given the continued low interest rate environment and the very strong indications that the ECB will adopt additional monetary stimulus measures on 10 March, it would be interesting to analyse the options available to income-seeking investors following the developments across the equity market over the past 12 months and whether there remain reliable companies offering relatively attractive dividend yields in the circumstances.

In last year’s article I had made specific reference to the three property companies whose business model enables the distribution of a consistent dividend on an annual basis.

The yields displayed on our website and other publications are based on the dividends distributed in respect of the last full financial year. Moreover, the yields quoted are generally gross of tax and investors need to factor in the tax at source (which in many cases is 35%) versus 15% final withholding tax for bonds. Since we are in the midst of the reporting season and only a few companies have so far published their financial statements and confirmed the dividends being proposed for approval at their respective upcoming Annual General Meetings, most of the yields referred to in today’s article are based on the payments made in respect of the 2014 financial year. In any case, it still provides an interesting comparison.

In fact, the share prices of the three property companies performed very strongly over the past 12 months with gains of over 40% for both Tigne Mall plc and Plaza Centres plc and 27% in the case of Malita Investments plc.

As a result of the significant appreciation in these equities, the corresponding dividend yields are somewhat lower. In fact, in the case of Plaza Centres plc and Malita Investments plc, the gross dividend yields have declined to 4.1% and 3.9% compared to 5.2% and 4.9% respectively a year ago. In last year’s article I had made reference to the dividend yields in June 2014 prior to the rally across most shares listed on the Malta Stock Exchange. By way of comparison, the dividend yields of these companies in June 2014 were 6.2% for Plaza and 6.4% in the case of Malita. This clearly shows the sharp decline in yields in less than two years.

The situation of Tigne Mall is slightly different as the rally in the share price was compensated by the higher dividend in respect of the 2014 financial year. In fact, despite the 46% rise in the share price, the gross dividend yield is practically unchanged over last year at circa 2.9%.

The decline in yields is also very evident in other companies whose share prices may have rallied in recent months mainly due to the spillover of demand from traditional bond investors who were seeking superior returns from selected equities.

MaltaPost plc is one such equity whose yield before tax dropped from 4.6% in early 2015 to 3.1% as the share price climbed by 45% over the past twelve months and the dividend to shareholders remained unchanged from one financial year to the next.

Likewise, the share price of Malta International Airport plc surged by over 55% over the past twelve months and the yield declined from a very attractive 6% last year (following the sharp improvement in the final dividend) to just 3.4% also due to the fact that last week MIA recommended a lower dividend to shareholders.

On the other hand, GO’s gross dividend yield improved by 60 basis points from 4.1% in early 2015 to a present yield of 4.7% notwithstanding the double-digit increase in the share price (also excluding any adjustment for the property company spin-off), as the absolute dividend surged by 42% from one year to the next. In fact, apart from the two large retail banks, GO is presently the highest dividend yielding equity on the local market.

The two large retail banks have been among the highest dividend paying equities for several years. The dividend yields of Bank of Valletta plc and HSBC Bank Malta plc moved in opposite directions since early 2015 for somewhat different reasons. The dividend yield of HSBC Malta improved from 3.7% to 4.7% both as a result of an 8% drop in the share price over the past 12 months, as well as an improved dividend over last year following a higher payout ratio and a lower charge in respect of Banking Rule 09. On the other hand, the dividend yield of BOV declined from 5.9% in early 2015 to 5.1% as the share price edged 16% higher and the overall dividend to shareholders remained unchanged (the reduction in the payout ratio was offset by a higher profit level). Despite the decline in the yield, BOV is presently the highest yielding equity in Malta.

Some investors may have also considered an exposure to a portfolio of international equities in order to generate a sustainable dividend income. It is worth highlighting that various companies in the US and UK have strong track records of growing their dividends on an annual basis. As an example, the global consumer business Procter & Gamble whose brands include Gillette, Oral B and Ariel among many others, has grown its dividend on an annual basis for the past 59 years! Other notable examples include Coca Cola as well as Johnson & Johnson at 53 years and Colgate-Palmolive with a 52-year track record of dividend growth.

Investors who have been investing in equities to improve their investment income and more importantly those who are still contemplating this course of action need to be aware that dividends are not fixed from one year to the next but may fluctuate depending on individual company circumstances such as cash flow requirements, capital expenditure plans, regulation, etc. Moreover, equities are also generally volatile reflecting a variety of factors including whether dividends are maintained or otherwise. This is especially important for investors who are generally accustomed to investing in bonds and are seeking exposure to equity purely for dividend income purposes.

While a stable dividend and a trend of generally rising share prices (as was experienced in most cases over the past 12-18 months), is good news for investors, the risks when investing in equity are far superior to bonds and these must not be overlooked.

Although interest rates are expected to remain at very subdued levels for many more years, it is important for investors to understand the different characteristics of various asset classes and the possible repercussions when shifting from one asset class to another.

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