Given the current uncertain market conditions, I wanted to provide an update on our expectations for income from the Switzer Dividend Growth Fund (ASX:SWTZ) in the year ahead.
As we have discussed in past notes, a number of factors combined to make 2019 a particularly strong year for dividend strategies such as SWTZ. These factors were primarily ‘one-offs’ (share buybacks and possible changes to franking credits under a Bill Shorten government) so, even before COVID-19, we were expecting distributions to return to a more ‘normal’ level this year. Given the effect the Coronavirus shutdown has had on the economy, we now expect the income dial to dip slightly beneath ‘normal’ for the short term.
Below are several important factors regarding our forecast for SWTZ distributions in the year ahead.
- The bank yields in FY2021 will be very important. NAB recently announced a significant cut to their dividend (30 cents for the half year, down from 83 cents last year), while ANZ and Westpac deferred their dividend. CBA is yet to give guidance on their dividend as they don’t report until August. As such, there remains a high degree of uncertainty around dividend payments from the big four for FY2021. It’s safe to assume, however, that dividends will be lower, particularly given the recent Australian Prudential Regulation Authority direction for banks to be conservative with their dividend payments. The good news is that the banks remain strongly capitalised, but the economic recovery from the lockdown period and the impact of bad debts need more time to be assessed. In our analysis we are assuming dividend yields of 4-5% from the major banks. We feel these assumptions are generally conservative. Our current position in the banks is around market weight, after having reduced these positions in the middle of last year.
- CSL is seriously distorting the yield forecasts for SWTZ. The company is now the largest stock in Australia (about 10% of the S&P/ASX200), and only yields around 1%. CSL is one of the Fund’s top holdings, but is also the largest underweight position compared to the benchmark. Despite the merits of the company, it holds SWTZ back from an income perspective. Our exposure to CSL at the end of April was 7.1%.
The natural next question here is: why hold CSL at all if it’s such a low income payer? Although most of the SWTZ portfolio is invested for yield, there is a portion that is invested to generate capital gains. CSL is one of the most successful companies on the ASX, with a great record of adding shareholder value despite paying small dividends. While a lower exposure to CSL over the past 12 months would have increased the yield of the portfolio, it would have come at the cost of significant capital gains.
- The current environment lends itself to companies holding back dividends even if they can afford to pay them. Those companies that are issuing debt to get through the downturn – rather than raising equity – are likely to sacrifice their dividends to do so. In this environment, there is a large range of companies that are likely to err on the side of conservativeness regarding dividends over the next year.
- We believe a strategy of chasing high short-term yields could be counter-productive for the medium and long term. This strategy may increase the risk of the Fund and will most likely deliver less in capital growth – potentially more than offsetting the benefit of a higher short-term dividend.
- The Fund is well balanced with a mix of growth and yield that makes us comfortable from a risk/reward perspective. COVID-19 has disrupted most companies in the portfolio, with the most obvious impact being a significant fall in dividends for FY2021.
Based on our analysis and considering the points above, we believe an income of around 2.7% (post fees) is a likely outcome for the Switzer Dividend Growth Fund over the coming 12 months. While significantly lower than previous years, this is modestly above our expectation of the dividend yield for the S&P/ASX200.
Our work shows franking in the Switzer Dividend Growth Fund is expected to be largely unchanged on the prior year at close to 100%. This would equate to a grossed-up yield of around 3.8%. There is still a high degree of uncertainty around this forecast but based on the information available today this is our best estimation.
We will continue to keep our investors informed if these forecasts change over the course of the year.
Thank you again for your continued support.