An ASX dividend pick for an uncertain time
An income pick for a higher for longer interest rate environment and elevated inflation.
Mentioned: Computershare Ltd (CPU)
The ASX closed for the year at 4pm on December 27th 2019. The index finished the year at 6821 but it is unlikely that many investors noticed. Summer was in full swing, New Years was right around the corner and thoughts naturally turned to 2020.
Almost four years later the ASX 200 sits at 6854 on October 26th 2023. The index has gone up a grand total of .004%. In real or inflation adjusted terms investors have lost money investing in the ASX 200 – except for one not so minor little detail. Dividends. Especially dividends that have been augmented by franking credits.
Dividends have made up approximately 50% of total returns in Australia over the past 60 years. However, the contribution from dividends has varied by decade. The greatest contribution to total returns came during the 1970s when dividends made up 85% of total returns. The 1970s were a decade of rising interest rates, stubborn inflation, geo-political tension and low market returns. Sound familiar?
I’m not going to win any awards for originality in comparing the current environment to the 1970s. And we have a long way to go before the decade ends. The economy and share markets could go in several directions but that doesn’t mean dividends should not be a focus for investors. I’ve recently written about how they can help provide income during retirement and they can benefit investors at any age.
What makes for a strong dividend payer
A strong dividend payer must be able to consistently generate income for investors and grow that income over time to account for inflation. Strong dividend payers have low business risk to provide predictability in different economic environments and have moats to fend off the competition. They are in strong financial shape.
Morningstar analysts provide their view on these key factors of each company within our coverage universe:
The Moat rating refers to how likely a company is to keep competitors at bay for an extended period. One of the keys to finding superior long-term investments is buying companies that will be able to stay one step ahead of their rivals, and it's this characteristic—think of it as the strength and durability of a firm's competitive advantage—that the moat rating measures.
We’ve identified five sources that give companies economic moats: Network effect, intangible assets, cost advantage, switching costs, and efficient scale.
Different companies have different fundamental risk levels. Some companies have stable and predictable cash flows; others might not be so stable or predictable. Companies are rated on five categories: Low, Medium, High, Very High, and Extreme. Factors that can influence a company’s rating include operating and financial leverage, sales sensitivity to the overall economy, product concentration, pricing power, exposure to material environmental, social, and governance risks, and other company-specific factors.
Capital allocation rating
Our analysts focus on three key things to assess how a company allocates capital. We assess the balance sheet, the investment track record, and shareholder distributions.
The key to building an income portfolio is to focus on not just on high dividends yields but also identify companies that will grow dividends over time. A portfolio containing both high current yields and high dividend growers can help investors generate current income and supply increasing incomes streams into the future.
Computershare (ASX: CPU)
Computershare services more than 25,000 firms globally by providing register maintenance services and adjacent areas like corporate actions or annual general meetings.
Over the past 6 years Computershare has grown their dividend by an average of 12% a year and we that growth to continue into 2024 with the current $0.70 cent per share dividend increasing to $0.92. The shares currently have a dividend yield of 2.78%.
Computershare’s yield is below the yield on the ASX 200. However, if the strong dividend growth continues into the future it will benefit investors if we are entering an extended period of low share market returns as a result of higher inflation and interest rates.
Morningstar analyst Shaun Ler assigns Computershare a wide moat rating. The firm’s diverse set of services—built up by acquisitions and supported by its superior technology—establish switching costs for its clients and facilitate cross-sell opportunities.
The low propensity to switch providers is evidenced by Computershare's improving client retention rate to nearly 100% and long client tenure. The reluctance of customers to switch makes it difficult for competitors to win market share, and growth normally requires acquisitions of other providers or is achieved by targeting IPOs, which Computershare has done over the years.
Generally speaking, medium-size and large companies don't change share registry providers unless problems occur with the service. The potential financial benefits of switching are normally outweighed by operational, reputational, and regulatory risks of doing so. Customers have a low tolerance for processing errors and value Computershare’s service reliability, functionality, track record, and registry-related services.
Ler assigns a Medium Morningstar Uncertainty Rating to Computershare. This is the second lowest rating on our uncertainty scale. The main risks to our forecasts are: uncertain interest rate movements, subdued economic/capital market activity, integration risk, as well as stronger-than-expected competition in the core registry business.
Group earnings will fluctuate with interest-rate movements. Approximately two thirds of group earnings before interest, taxes, depreciation and amortisation comes from interest on client-owed cash balances. The higher the interest rates the better Computershare does which is in contrast to many other companies who suffer in high interest rate environments. Computershare is likely to benefit in a higher for longer interest rate environment.
The core business is exposed to macroeconomic/capital market activities that tend to act in unison. Cyclical fluctuations in share market activity generate substantial shorter-term volatility in trading volumes and earnings. The mortgage servicing business attracts some regulatory, interest-rate, and early repayment risks. The global footprint also means foreign exchange moves can affect earnings.
Capital allocation rating
Computershare’s capital-light business model and high proportion of recurring fee revenue support a sound balance sheet, and hence regular dividends.
Ler believes the company’s financial strength will stay resilient in the face of any cyclical market downturns. No dilutive equity raisings were undertaken during recent market shocks, including the 2020 coronavirus recession and the subsequent stock market decline.
Computershare's ability to generate cash and a sound balance sheet means it's reasonable for the company to return cash to shareholders via dividends. Ler considers the dividend payout ratio—which we forecast at around 50%—to be a reasonable balance between returning capital to shareholders, reinvesting in the business, acquisitions, and maintaining a solid balance sheet. Earnings are only modestly franked, reflecting the global nature of Computershare's earning.