If you took R20 000 to Absa and asked them to put it in a 90-day notice account, you would get offered an interest rate of between 5.65% and 5.95%. If you took that same R20 000 and invested it in Absa shares, you could expect a starting dividend yield of around 7.15%.
“And because of the nature of equities, we would like to believe that Absa will also grow its dividend ahead of inflation,” says Andrew Vintcent, portfolio manager at ClucasGray Asset Management. “But you won’t get any growth out of cash in the bank.”
Absa may not be everyone’s favourite stock, but this is an eye-catching anomaly. A starting yield higher than the rate you can get from cash is a rare phenomenon.
‘Too good to ignore’
What is even more telling is that Absa is not an extreme outlier. Nedbank is offering a dividend yield of 5.5% and Standard Bank 5.65%, both of which are in line with notice deposit rates. Vintcent says that these kinds of numbers “feel too good to ignore”.
“Our banks generate a return on capital in the high teens,” he explains. “Even Absa, which has been out of favour, has a return on equity of around 17%. That means that they are generating new capital every year.”
In an environment where advances growth is strong, which would be a positive story, these banks would have to hold on to some of this capital to meet regulatory requirements. However, if credit growth is weak, as it has been in South Africa, they are not required to hold that much, and they could be in a position to reward shareholders through increasing dividends.
In other words, the margin of safety for investors is extremely attractive. If the economic environment improves, earnings are likely to improve, and share prices could follow. If it doesn’t, investors can still expect handsome dividends.
These bank stocks tell a particularly interesting story, but they are not alone. Dividend yields are elevated across the market.
To illustrate this point, ClucasGray put together a theoretical portfolio of eight shares that have been listed for at least 20 years. These are not companies that the firm necessarily holds in its funds, but they are indicative of the overall market as they cover a range of domestic sectors. The eight counters are: Foschini, Truworths, Sanlam, Absa, Standard Bank, Massmart, Imperial and Aspen.
The blue line in the below graph shows the dividend yield for South African banks. The red line is the dividend yield on these eight stocks.
Not only are these yields elevated, they have been rising rapidly. The risks to investors would therefore appear to be declining, rather than increasing. Vintcent uses industrial counters as an example.
“We have recently been buying Imperial, and post the unbundling of Motus, have been adding to our positions in both,” says Vintcent. “While earnings prospects may not be exciting for either, the valuation is extremely compelling. On our estimates, Motus was trading post unbundling on a price-to-earnings multiple of less than 8x, which for a dominant player in the South African vehicle and ancillary industries is inappropriate.”
It is true that vehicle sales in the country have been pretty flat for the last six years. The chart below shows the 12-month change in vehicle sales since 1991, and one can see how tepid the most recent period has been.
However, Vintcent believes that this weak macro picture is already more than reflected in the prices investors are being asked to pay. In fact, he feels that too much negativity is now priced in.
“This economy hasn’t been tough for two quarters or two years,” he points out. “It has been an economic grind for seven years. The earnings bases of these domestic names have already absorbed a period of protracted economic weakness. The potential is that investors are being asked to pay low multiples for what could turn out to be trough earnings.”