Last week we focused on income investing. In case you missed it we published articles on why I’m an income investor, explored retiring on dividends, looked at a key metric for income investors and how to build an income portfolio.

In many of these articles we cautioned investors against simply buying the highest yielding shares. Today we are looking at the three highest yielding shares in our coverage universe with a wide or narrow moat rating which indicates a sustainable competitive advantage. At Morningstar we believe that moats matter.

A moat refers to a company that has a sustainable competitive advantage. One thing that is important when evaluating a company is to remember that capitalism is competition. And while companies competing for new business by creating better goods and services at cheaper prices is positive for consumers it does not benefit shareholders.

Companies are forced to spend more money on research and development and marketing. When combined with lower prices that means lower profits. Over time we believe that the impact of competition is that over the long-term most companies will earn returns that are equal to their cost of capital 

As a reminder the dividend yield is calculated by dividing the dividends received over the past 12 months by the share price. This is a backward-looking measure. Dividends can be cut or eliminated and what matters to investors is what happens in the future.

Accent Group (ASX: AX1)

In 2023 Accent Group paid a dividend of $0.18 a share. Given the current price of $2.09 that equates to a dividend yield of 8.6%. Not too bad.

Accent Group is a retailer and wholesaler of footwear and apparel. It is the exclusive distributor of range of global brands, including Skechers, Vans, and Doctor Martens in Australia and New Zealand.

Accent operates both monobranded stores and multibrand banners, such as Platypus, Hype DC, and The Athlete’s Foot. With a network of more than 700 physical stores and 30 websites, Accent is the largest footwear retailer in Australia.

We assign Accent Group a narrow moat rating based on its intangible assets, which include strong relationships with leading footwear brands and an extensive store network.

Intangible assets include patents, brands, regulatory licenses, and other assets that prevent competitors from duplicating a company’s products or allow the company to charge higher prices. 

Long-standing, and in many cases exclusive, distribution agreements with the world’s largest footwear brands, combined with an impeccable track record of favorable contract renewals, give us confidence that Accent can continue to deliver returns exceeding its weighted average cost of capital.

We have a fair value of $2.40 and the shares are trading in the fairly valued range given the high uncertaintity rating and the margin of safety that we believe investors should take into account.

We do not believe the dividend payments in 2023 will be sustainable going forward. Fiscal 2024 is shaping up to be a tough year. Our flat fiscal 2024 sales growth forecast is buoyed by new store openings, with like-for-like retail sales expected to fall by a little over 2%.

Costs of doing business, particularly wage and lease expenses, are also expected to rise, driving Accent’s fiscal 2024 operating margin down to a forecast 7%—from 10% in fiscal 2023. This should see EPS fall to $0.09, 45% lower than last year.

Accent has historically paid a dividend of 75%-80% of net profit after tax. Given the drop in earnings we also believe the dividend will drop from $0.18 to $0.068 a share. According to our analysis this may be a dividend trap over the short-term that income investors may wish to avoid.

A dividend trap occurs when investors buy a share expecting previous dividend payments to continue. In many cases the yield is elevated as the share has sold off as investors anticipate hard times ahead including dividend cuts. This may be the case with Accent as shares have dropped nearly 20% since mid-April. 

Atlas Arteria Ltd (ASX: ALX)

In 2023 Atlas Arteria paid a dividend of $0.40 a share. Given the current price of $5.36 that equates to a dividend yield of over 7%.

We believe Atlas Arteria has a narrow economic moat underpinned by efficient scale. Its most valuable investment is a 31% stake in Autoroutes Paris-Rhin-Rhone, or APRR, which owns a concession over the main tolled motorway network in eastern France.

When a niche market is effectively served by one or only a handful of companies, efficient scale may be present. 

Atlas also owns the concessions to Dulles Greenway and Chicago Skyway in the U.S. For toll roads, new entrants are deterred by inelastic demand and substantial upfront construction costs.

A difficulty in securing land and planning permission further deter new entrants. We also believe the roads benefit from a form of switching cost due to time savings compared with non-tolled alternative roads. We estimate the time saving between Paris and Lyon is around two hours, or 30%, compared with the non-tolled alternative route. A relatively short concession life of 12 years for APRR precludes a wide moat.

APRR is a large, hard-to-replicate motorway network with relatively defensive revenue. Trade and tourism are key drivers of traffic volumes, which tend to grow slightly faster than real GDP. Toll prices follow a set path--base increases of 0.7% of CPI excluding tobacco.

Upgrades to the roads such as adding extra lanes to alleviate traffic congestion are negotiated with the government in return for additional toll price increases or concession extension. Upgrades generally provide attractive risk-adjusted returns.

Supplemental toll increases to compensate for higher land tax, the 2015 toll freeze, and additional capital expenditure will see tolls grow slightly faster than CPI for the next few years. If new contracts on fair terms can't be agreed with the government, tolls and capital expenditure revert to the base schedule. French CPI is currently subdued, resulting in weak toll-price growth.

Our fair value is $5.85 and the shares are currently trading as fairly valued.
In 2024 we believe that Atlas Arteria will maintain the current dividend of $0.40 a share which will rise slightly to $0.41 in 2025.