Dividend growth stocks trump Reits amid rate hike-driven volatility

Singapore

AS interest rates perk up and bond yields rise, investors betting on Reits and other erstwhile defensive "bond proxy" dividend stocks for income are being forced to rethink their strategies.

Reits and other dividend-paying equities which are viewed as "bond proxies" are having to compete for capital with the actual things as bond yields rise in a market primed for faster Fed rate hikes.

Sat Duhra, co-portfolio manager of Janus Henderson's Asian dividend income strategy, told The Business Times: "Traditionally, investors were willing to hide in Reits, telcos and utilities which would perform well in market volatility. However... this pick-up in volatility has been accompanied by rising rates which have made the yield here less attractive."

Instead, Mr Duhra said it would be more rewarding to move into "cyclical names where dividends are rising at a rapid pace. Dividend growth is more favourable here."

A poll of pundits by BT showed banks were widely preferred as were some smaller dividend growth stocks, while Reits, and Singapore's telcos were deemed unattractive next to regional peers.

Kum Soek Ching, Credit Suisse's private banking research head for South-east Asia, told BT: "Today, Reits are not in bargain territory, so you have to be selective. Look at the Reit's yield spread relative to the 10-year Singapore government bond and compare that to the historical average spread to gauge the Reit's relative attractiveness.

"The average yield spread now is more attractive than it was three months ago, but relative to the historical average (3.76 per cent) it's still not a screaming buy. We are still looking at interest rate increases so that will still weigh on the Reit sector."

Some wealth managers are also concerned that Reits have become a lot more acquisitive of late.

Jeffrey Ong, director at Bank of Singapore, prefers to pick stocks with a dividend payout ratio of 50 per cent or lower.

He said: "Reits fail this criteria. A 90 per cent payout ratio means they have no buffer. In case they need money for acquisitions or refurbishment, they will either have to raise debt or do an equity dilution."

Mr Ong reckons that small-cap dividend growth stocks like CSE Global, the process control and communications network system integrator which came into play earlier this year, could be a better bet instead.

Analysts at KGI and RHB both initiated coverage on CSE Global last week, eyeing more contract wins from customers riding the upturn in the oil industry and the US onshore oil boom.

KGI analyst Joel Ng is tipping earnings growth of more than 20 per cent over the next three years.

He wrote: "Management has maintained its guidance for a 2.75 Singapore cents full-year dividend, which would mean a final dividend of one Singapore cent, offering an attractive 6.4 per cent dividend yield. It has consistently paid 2.75 Singapore cents per annum over the past four years. We estimate that CSE Global can sustain this dividend going forward as balance sheet remains in net cash position of S$20.9 million while free cash flows are sufficient to cover the annual dividend payout of S$14 million."

Janus Henderson's Mr Duhra also advocates a dividend income strategy that recognises the strong performance of cyclical names over the last two years.

Roughly half his portfolio comprises dividend growth stocks, picked for their potential to grow cash flows and dividends.

Mr Duhra explained: "The strategy has moved towards domestic cyclicals such as consumer, materials and energy to capture rising earnings in Asia without compromising the overall yield of the strategy. This has reduced the interest rate sensitivity of portfolio holdings whilst adding greater capital upside from structural growth names in Asia."

All of his big dividend surprises this year have come from the energy and materials sectors, he added: "We have focused specifically on E&P (exploration and production) majors and refining names. E&P names in China and Thailand are particularly attractive given valuations based on the spot oil price. Balance sheets have been improving, free cash flow generation is strong and dividend increases have almost become the norm in the sector in Asia with all of the large players upping dividends. Stocks such as Sinopec in China have performed strongly yet paid very high dividend yields at around 8 per cent."

Lately, Mr Duhra has also been adding banks and insurance stocks, which are less sensitive to trade tariff-induced concerns.

As the market enters a new earnings season, banks are the most preferred across all cyclical stocks for their "bottom-line resilience", OCBC analysts wrote in a report.

Carmen Lee, head of OCBC Investment Research, told BT last week: "We like both DBS and UOB. At current prices, DBS's dividend yield is estimated at 4.8 per cent. For UOB, it is 3.9 per cent. We like that banks have strong balance sheets and will also be able to benefit from the higher interest rate environment."

But other stalwarts of the defensive yield sport have disappointed this year. Singapore's telcos continue to be unattractive, Morgan Stanley analysts noted.

"While Singapore telcos offer the highest yield (5.6 per cent) among South-east Asian telcos, we believe the dividends are not sustainable given the competitive operating environment, and should decline. Singapore continues to be least preferred," analysts led by Sean Gardiner wrote in a report last month.

Most brokers prefer NetLink NBN Trust, the owner of Singapore's fibre optic cable, over telcos.

Morgan Stanley analysts wrote: "At 6.1 per cent yield, we think NetLink should trade at a lower dividend yield than the Singapore Reits given its higher growth - we forecast a 5.2 per cent dividend compound annual growth rate (over the next three years) versus 1.7 per cent for the Singapore Reits."

OCBC Research also likes NetLink, though Hong Kong-listed CK Infrastructure is the house's top pick among regulated infrastructure businesses: "Both companies typically operate in regulated regimes, with long-term contracts, and stable businesses. We think it is opportune to revisit the merits of players in regulated infrastructure industries, given their general resilience to cycles and trade dynamics."

To be sure, dividend growth for Singapore's largest blue chips is expected to slow down next year, Morgan Stanley observed: "While Singapore and Malaysia are high on yield, we expect 2018 dividends to decline and while 2019 will recover, it is not as strong."

But the benchmark MSCI Singapore index still offers the highest dividend yield in South-east Asia, followed by Malaysia.

Pundits generally agree that Singapore remains the most attractive market in the region to hunt for yield, once the relative strength of the Singdollar against emerging market currencies is taken into account.

Phillip Securities head of research Paul Chew said: "We would stick to the Singapore dividend stocks. The Singapore dollar has strong fundamentals backed by large current account surpluses and huge foreign reserves. Furthermore, in the background there is a currency tightening bias by the central bank."

On which dividend-paying stocks might perform best in a recession, OCBC's Ms Lee said: "Unfortunately, in a broad market sell-down, dividend stocks are not spared. However, it is better to focus on quality and fundamentally sound companies. Most of the Straits Times Index stocks are well-run companies with long operating histories. They have seen several business cycles (up and down) and this should also help to ensure that these companies are in a stronger position to ride our business down-cycles."

CapitaLand Commercial Trust and Ascendas Reit (AREIT) are Phillip Securities' favourite yield stocks.

Morgan Stanley likes AREIT and Keppel Reit (KREIT), its analysts wrote on Sept 26: "We believe AREIT can continue to achieve sustainable dividend growth at a pace of 2-3 per cent per annum helped by its positive exposure to business parks. At 6.4 per cent dividend yield, we believe AREIT's share price implies a larger unit base from its recent acquisition but not the income contribution arising from the to-be-acquired UK and Singapore properties.

"We see KREIT growing its dividends by 4-5 per cent per annum in 2020-2021, driven by rising market rents and inorganic growth. Share buybacks, revaluations and divestments could potentially close KREIT's share price gap to its NAV (net asset value), currently at a 15 per cent discount. At 5 per cent dividend yield, we believe KREIT's share price implies an office upcycle, but does not price in the potential for NAV gains."

For investors still keen on seeking yield offshore, DBS Group Research analyst Yeo Kee Yan recommends countries with currencies that have been strengthening against the Singdollar, like Hong Kong and Thailand. He advises avoiding currencies with weakening currencies like Indonesia.

In Hong Kong, DBS's dividend picks are Bank of China, BOC Hong Kong, HKBN, HKT Trust and China Construction Bank. In Thailand, the broker likes Digital Telecommunications Infrastructure Fund, Kiatnakin Bank and Tisco Financial Group.