Commodities players, a fuel distributor and a media company were among the highest dividend-paying stocks in 2019, and they're tipped for similar success in 2020.

Dividends are crucial for those who are already retired or nearing retirement. The potential for fully-franked dividends are also one of the key reasons so many Australian investors prefer local stocks.

Dividends are also unaffected directly by the broader share market performance, and are often viewed as a safety net during periods of heightened volatility.

These points are emphasised by professional investor Anton Tagliaferro, founder and investment director at Australian asset manager Investors Mutual Limited.

"Over the long term, returns from an equity portfolio come from two sources – the capital appreciation from the shares held in the portfolio, as well as the dividends received from the shares held," Tagliaferro says.

He notes that, when viewed over both 20-year and 40-year timeframes, dividends contributed almost half of the returns generated by the Australian share market.

"And while the level of capital returns from an equity portfolio over any defined period generally depends on the movement in the share market, the level of dividends received by an investor from an equity portfolio is dependent on the performance of the underlying companies’ earnings, not the movement in share prices."

Beware dividend traps

Before delving into the highest dividend-paying stocks themselves, it's important to remember that you shouldn't view dividends in isolation.

The price paid for the shares should also be weighed alongside the potential dividend yield. Some companies have high payout ratios but have far less stellar fundamentals. In some cases, abnormally high dividend yields can be a danger sign, as suggested in this article by Morningstar Spain's Fernando Luque.

Overvaluation is one risk of high dividend paying stocks, as share prices can be bid up by yield-hungry investors.

There's also the risk that companies may lure investors in with the promise of dividends – perhaps funded by high debt – only to cut dividends later if market conditions deteriorate.

 

Investors need to tread carefully. But looking at stocks within Morningstar's research coverage over the course of 2019, the following stocks were the top five in terms of dividend yields:

Alumina (ASX: AWC)
Whitehaven Coal (ASX: WHC)
Z Energy (ASX: ZEL)
Sky Network Television (ASX: SKT)
Southern Cross Media (ASX: SXL)

Aluminium refiner Alumina distributed 11.4 per cent of its earnings as dividends last year, paying a total of 26 cents a share in 2019.

But this company may well be an example where healthy dividends don't necessarily compensate for problems in other parts of the business.

With a share price of $2.28 at the market open on Monday, Alumina shares are currently around 50 per cent above Morningstar's $1.50 fair value estimate.

"Our negative outlook stems from our bearish forecast for alumina prices, as we forecast a midcycle alumina price of US$ 270 per metric ton, well below price levels observed over the last couple of years," says Morningstar equity strategist Andrew Lane.

Prices of alumina remain considerably higher than Morningstar's long-term forecasts. Lane doesn't expect returns to compensate for a higher cost of capital – even though the company is a lower-cost producer of the metal and is expected to report higher economic profits for 2019 than in 2018.

"Like our outlook for alumina prices, we forecast that primary aluminium prices will remain lower for longer as Chinese fixed-asset investment wanes," Lane says.

"Accordingly, we'd advise that investors avoid the broader aluminium industry and seek out greener pastures."

Whitehaven lucky and good

Mining company Whitehaven Coal paid out 10.5 per cent of its earnings as dividends in 2019.

The company's balance sheet remains healthy thanks to high coal prices as China demand for metallurgical and coking coal have held up. This saw dividends to shareholders re-started back in 2017 and capital returns of 80 cents a share up to and including the fiscal 2019 interim dividend of 20 cents.

"Future capital allocation is key. Whitehaven was lucky to repair its balance sheet so quickly with the recovery in coal prices in 2016 and 2017; the outcome could have been very different," Morningstar equity research director Mathew Hodge says.

Hodge last month cut his fair value estimate for Whitehaven, on the back of management's lower production forecast for fiscal 2020. But the company's share price of $2.60 at Monday's market close sees it trade at a 34 per cent discount to Morningstar's fair value estimate of $4.

Better times ahead for Z

Kiwi fuel distributor Z Energy supplies fuel to nearly half the transport operators in New Zealand, delivering a dividend yield of 10.35 per cent in 2019.

Morningstar senior equity analyst Mark Taylor points to the company's increased earnings before interest, tax, depreciation and amortisation, which jumped to 12 per cent between 2010 and 2019. "And it has achieved this in an environment of stagnating fuel sales volumes," he says.

But the company has seen a decline in the margins from both its refining and retail operations, and Taylor sees further headwinds over the shorter term.

This has prompted a downgrade in its fiscal 2020 dividend forecast, which had been targeting 48 NZ cents but has since been cut to 40 NZ cents. But yield remains a key attraction of Z Energy, Taylor says.

He recently maintained his fair value estimate of NZ$ 8.30 (A$ 7.70), and continues to see current difficulties linked to retail price competition and fuel discounting as short-term rather than long-term.

Z's share price of $4.26 as at Monday's close is 44 per cent below Morningstar's fair value estimate of $7.70.

Sky addresses a changing market

Alongside a dividend yield of 10.25 per cent for 2019, Sky Network Television also ranks as one of Morningstar Australia's most undervalued stocks. 

"We see Sky as having a sustainable business longer term, albeit our midcycle EBITDA margin of around 20 per cent is far cry from the mid-30 per cent level enjoyed before the onslaught of streaming competition took hold," says Morningstar senior equity analyst Brian Han.

He believes the market is ignoring several encouraging signs, including:

  • a subscriber base that is nearing an inflexion point
  • new management's commitment to streaming within the broader business plan
  • investment in compelling content and key sports rights.

Sky had a net gain of 11,000 subscribers in fiscal 2019 – its first lift in three years, as a loss in satellite subscribers was offset by 54,000 new streaming subscribers.

The company's share price of 71 cents at Monday's market open was a 41 per cent discount to Han's fair value estimate of $1.20.

Radio plays an upbeat tune

Southern Cross Media rounds out this list with a dividend yield of 9.12 per cent in 2019.
A market leader in radio coverage, Southern Cross faces challenges but it is nevertheless trading at just 8.1 times to Han’s forecast fiscal earnings per share and is yielding a sustainable 7.4 per cent fully franked dividend.

“In a widespread advertising downturn, all one can ask for is that Southern Cross maintains its share,” says Han. “We believe it is doing so.”

Han’s five-year forecast points to a “tepid” annual revenue growth rate of 1.2 per cent but he stresses that Southern Cross Media has managed to maintain a 30 per cent share of the radio advertising market despite unprecedented industry disruption.

Around 80 per cent of the company's earnings comes from radio, and it has been narrowing its focus on this segment with a divestment of its regional NSW television service in mid-2017.

“This conscious effort to be more radio-centric is management's response to the structural threats posed by digital technology whose decimation of the TV and print media industries have been well-documented," Han says.