Impact of Malaysia General Election (GE14) on Investment Portfolio

The world has just witnessed an orderly transition of power in Malaysia following the result of GE14.  A change in federal government after 6 decades!

As an income investor, the ultimate question that cross my mind is,  how would the change in government impact the various sectors? 

1) We have seen the sharp plunge in share prices on stocks whose fortunes are perceived to be linked to various contracts dished out by the previous BN government such as MYEG, Destini, Gamuda etc. Imagine you hold MYEG and the price plunged from RM2.6 before GE to RM0.9 level as at end-May 2018, that is 65% paper loss. I will usually stay out from political linked counters, although certain political linked counters could generate handsome return.

2) With the zerorisation of Goods & Services Tax in June onwards and Sales & Services Tax scheduled to be implemented in September, there will be 3 months of tax holiday, I suspect consumers may ramp up their spending again. Consumers have more income in the pocket to be saved or consumed. Consumer sector will rejoice, if the GST abolishment results in revenue shortfall of around RM20 bil to government coffer, it means additional RM20 bil in the domestic system that could be spent. 

Source: ET Strategic Marketing

Besides, fixing RON95 at a fixed level while RON97 to float, is also a welcome mechanism for most consumers amidst the higher oil prices now. Consumer sectors i.e. Auto sector, Brewery, Apparel makers , Retail Mall REITs will be the key beneficiary, no doubt about it.

3) With toll abolishment manifesto, expect this to be a very gradual development as government will need to balance the manifesto agenda vis-a-vis financial position. If tolls are being abolished, there shall be compensation to toll concessionaire. Stocks that are impacted e..g. Litrak & Gamuda (one of the shareholders of Litrak). Shareholders who invested in Litrak stocks for dividends will need the consider if the toll is being abolished in the interest of the nation, what sort of equity value will accrue to the shareholders?

4) Tenaga Nasional, a monopoly in the domestic electricity distribution business, may be impacted if the new government disagree with the implementation of ICPT (imbalance cost pass through) mechanism. With higher fuel prices & other generation cost, the rising cost will be passed to the consumers if electricity tariff is being increased under ICPT mechanism so that the higher cost will not impact Tenaga Nasional's financials adversely. With new government's objective to address the concerns of rising cost of living, it remains to be seen if the electricity tariff can be increased in June since the tariffs are being reviewed every June and December. If ICPT cannot be implemented, how would TNB shoulder the higher cost? will government provides enough subsidy to assist TNB?

The abovementioned impact is not meant to be exhaustive, the clear winner from my quick thought?

Consumer sectors, higher consumer income will support the sector's earning sustainability and growth moving forward.

Should You Rejoice over 100% Dividend Payout Policy?

2018 valentines day was indeed a happy day for Carlsberg Malaysia shareholders as the board formally announced a new dividend  policy whereby Carlsberg Malaysia will pay 100% of its net profit to shareholders moving forward.

In fact, it has paid average 100% or more of its net profit in the past 3 years (2015 -2017), hence the announcement was basically to formalize the new dividend payout policy.

Can Carlsberg Malaysia afford to pay out 100% of its net profit?

1) It is in net cash position ( cash balance > debt balance) in 2017.

2) Healthy current ratio (current asset > current liabilities) of more than 1x in 2017.

3) Strong free cash flow position ( operating cash flow > capital expenditure) in 2017.

4) Business is relatively stable and not highly cyclical, although subject to seasonality like festive season. When economy is bad, people may even drink more.

5) No material litigation against the company but bear in mind it has RM55 mil of custom duty or tax liability if it crystalize.

Based on the above, it seems like Carlsberg Malaysia is in a position to adopt 100% dividend payout policy. 

   Source: Dividend.com

However, not all is rosy with 100% payout ratio. If a company's profitability declines, there could even be a possibility of dividend cut.

Hence, while shareholders rejoice over the 100% dividend payout policy, close monitoring on its future business performance is still critical to assess if the payout is sustainable over the long run, especially if it pays above 100% of its net profit on prolonged basis.

Should Dividend Investors be Worried on Rising Interest Rate in US?

Dow Jones Industrial Index (DJIA) plunged more than 1,000 points on 8 February 2018 and various media highlighted the concerns on rising inflation plus rising interest rates in US being the cause of the stock market decline.

The decline in global stock market again validate the idea that some investors succumb to herd mentality and swayed by emotions brought by the volatilities in the stock market.

Rising US interest rate will cause US government bond yield to increase (higher bond yield means lower bond prices), thus decrease the attractiveness of dividend yield stocks, hence investor should sell their dividend stocks,, do you agree? 

The above is the statement that you may have read from various media, what happen if we let go of our independent thinking and follow the media? we will be in for a roller coaster ride, not a good idea.

Firstly, dividend investor who aims to live off dividend income, should ignore any short term noises in the stock market. Why is that so?

1) If US inflation and interest rate increase due to stronger underlying economy i.e. low unemployment rate, robust wage growth. Isn't this a good news to equity investor in the long run?

2) If economy performs well and US consumers increase their spending on goods and services, isn't this a good news to equity investor in the long run?

3) If global economy has a synchronized recovery, thus higher inflationary pressure after many years of low interest rate and subdued inflation, isn't this a good news to equity investor in the long run?

4) If better economy translates into better company's profitability, even if dividend payout ratio remains the same, investors will benefit from higher dividend income due to higher dividend per share on the back of higher earning per share, isn't this a good news to equity investor in the long run?

Ultimately the key factor for dividend investor to assess will be the competitive advantage of the business that we are investing in, no doubt higher interest rate may cause increase in cost of borrowings or cost structure and thus impact a company's bottom line, what if the company engages in effective hedging policy or having large portion of fixed rate borrowings or possess pricing power to grow its profitability in the long run amidst higher interest rate environment?

To name a few, If companies such as Procter & Gamble (P&G), Coca Cola, 3M, Colgate Palmolive and Johnson & Johnson (J&J) are able to increase its annual dividend payout in the past 50 over years over various interest rate cycle, really the key focus for income investor is to search and invest in companies with the prospect of increasing its profitability and dividend payout in the long run.

What about the share price?

It will take care of itself for a strong fundamentals company in the long run.

Capital Loss of 50% in REIT Investment is Possible

Imagine you invest in Sabana REIT at SGD0.95 in November 2012 and hold your position until today. With closing price of SGD0.46 as at 26 October 2017, we can kiss our capital goodbye unless there is strong rebound in share price and significant increase in dividends to offset the loss.
 

Otherwise, to recover from 50% capital loss, we need to earn 100% return on our investment, just to breakeven. Even if we can earn 100% return, the key question to ask is, over how long? 

Hence, taking care of downside risk is critical as losses drag the portfolio return.
 

Sabana REIT is the first Shariah-compliant REIT listed in Singapore back in 2010, it owns and invests in income-producing real estate used for industrial purposes. Sabana REIT's portfolio comprised 20 industrial properties such as chemical warehouse which are located near to expressways and public transportation across Singapore.

What went wrong over the years?
 

1)      Net Property Income declined since 2013 to 2016.

 

2)      Income available for distribution declined from SGD60 mil in 2013 to SGD37 mil in 2016, yes that was like reduction of 38%! Needless to say, distribution per unit has also declined over time, it is like receiving lower amount of passive income or dividend every year which is not fun.

 

3)      Total debt over asset (leverage ratio) which measures level of indebtedness of the REIT, increased from 34% in 2012 to 43% in 2016, approaching regulatory limit of 45%.  Rising leverage ratio is also due to the fact that the property valuation has decreased over time with the REIT registering negative changes in fair value of properties. As the fair value drops, the debt ratio will increase even if the debt amount remains unchanged.

 

4)    Poor outlook for industrial properties generally, might have weighed on Sabana REIT too. That said, Mapletree industrial REIT seems to be performing well, both appear to be operating in same industry, but a stark contrast in terms of fortune.
 

5)      Rising fees paid to the REIT manager despite poor performance.
 

Lesson to Learn from this Case:

1)      Beware of REIT that experience consistent negative valuation on underlying properties, falling net property income, rising debt to asset ratio. Do compare the REIT performance against peers, the better performing ones tend to be better managed.

 

2)      Stick with REIT with good fundamentals to optimise chances of earning positive total returns.

 

3)      Lastly, do not invest into REIT purely based on highest dividend yield, Sabana REIT has 9% dividend yield in 2014, looks tasty, but comes with high risk. Always go for dividends that are Safe.

Reflection on Bird in the Hand Theory

When I was in college, I remember my finance professor talked about bird in the hand theory in the classroom, I paused for a while as I was wondering what is the relationship between a bird and finance theory.

 

He went on to explain that the theory postulates investors prefer dividends compared to capital gains as capital gains can be highly uncertain.

Hence, bird in the hand (dividend) is worth two in the bush! (referring to capital gains).

What the theory miss out is that the bird in the bush may fly higher, giving investor good capital gains!

There is also dividend irrelevance theory where it postulates that investor could sell shares and realise the capital gain and treat it as a dividend, hence dividend policy should have little or no impact to share price.

What the theory miss out is that dividend does have an impact on a company’s share price, imagine if a company keeps increasing or cuts its dividend, there is a high probability that the share price of the firm might react positively or negatively.

As an income investor, we should value the stream of sustainable dividends paid by the companies, but it doesn’t mean we will neglect the potential capital gain over the long run.

We want BOTH.

Dividend + Capital Gains = Total Return

By investing into quality companies that pay sustainable and rising dividends, its share prices are likely to increase over the long run, giving a BOOST to investor’s total return in holding the specific stock.

No matter where the bird is, either in the hand or in the bush, it will be great to capture BOTH.

Magic Formula to Double Our Investment Portfolio

Fancy a formula that will tell you how many years will it take to double your dividend income? Or double your investment position?

 

Say hello to rule of 72. This is a powerful rule! Let’s find out why..

 If your invested company paid RM0.50 dividend per share this year and based on your purchase cost of RM10 per share, your passive income or dividend yield will be 5%.

 

Dividend Yield on Cost= Dividend per Share / Purchase Cost

The company has a track record of increasing its dividend payout in the past in line with higher profitability and free cash flow. Assuming 5% dividend growth per year, the dividend per share will double to RM1 per share in around 14 years time. What does it mean to us then?

1) Dividend per share doubled in 14 years time. Even if number of shares that you hold remains constant, higher dividend per share means higher amount of dividend received.

 

2) If you have accumulated more shares along the way, the amount of passive income received would have increased tremendously.

 

3) When a company pays higher dividends, most often that not, the share price is likely to have upward pressure too.

 

4)  Peace of mind because not many companies can consistently increase its dividend, you would have likely found a company with solid fundamentals.

 

14 years for dividend per share to double may seem like a long long wait. Assuming a company dividend yield based on your purchase cost is 4% and dividend paid per share remains UNCHANGED, if you could earn another 4% return from capital appreciation on yearly basis over the long term. Your total return average to be 8%, so how many years will it take to double your investment position?

 

Yes, 9 years.

 

If we invest RM100k at the age of 30 and do not bother to invest fresh capital anymore and the portfolio generates long term average return of a conservative 8%.

At the age of 39- portfolio double to RM200k

At the age of 48- portfolio double to RM400k

At the age of 57- portfolio double to RM800k

So on and so forth, that’s the power of RM100k in present value terms that could potentially yield much much more in the future.

What if you top up your investment consistently along the way?

What if the company increase its dividend payout? Since we assume dividend paid per share remains unchanged in the above scenario which is a highly conservative assumption.

What if the company share price gain more than 4% on a yearly basis?

Dividend Investing  + Rule of 72 are definitely a powerful combination we should keep in mind.

Beware of Dividend Cut- It Hurts!

Much has been talked about investing in companies that pay higher dividends year after year, so that we could receive larger amount of passive income year after year.

Dividend growth is SWEET to hear, what about the company that you invest into CUT its dividend payment?

Dividend cut is surely the two unpleasant words a dividend investor would like to hear generally speaking.  A company may cut its dividend if its profitability position declines i.e. falling profits, this may lead to decline in share price and could hit investor twice in terms of lower dividend received and potential capital loss or reduction in unrealised gains.
 

If a company cuts dividend due to the need to conserve more cash for near term project expenditure which may contribute to better profit in the future, this situation does not warrant caution still. But if the dividend cut is due to decline in profits and investors do not expect near term significant recovery in the company’s profitability, the investor better adopt a cautious hat.

One example is Lafarge Malaysia Bhd which involves in the cement industry, that has been hit hard in recent years due to fierce competition in cement industry, rendering depressed cement selling price, and it was loss-making in 1Q 2017.
 

If you look at the dividend payment trend below, its historical dividend has been healthy and investor should not assume the dividend payment trend to repeat as it very much depends on the profitability of the company or industry.

Lafarge cut its dividend in 2016 in view of the challenging operating environment.  Needless to say, share price has also plunged from around RM9 in early 2016 to current share price of RM5.7,  it translates into 37% loss in share price.

Hence, when we invest into cyclical companies that pay stable dividend in the past, we should always be cautious on the possibility of dividend cut due to fundamentals of the company or industry turning bad.

 

Dividend cut and share price decline are definitely, a blow to an investor portfolio.