As the developed world’s consumers maintain a process to vigilantly reduce debt, it is likely that the only event that will change their collective sombre moods would be a spirited recovery in political leadership. In other words a sense that the world’s leaders see the problems, can accurately describe them and have the answers or solutions. It would be good to have a message that we are in safe hands and that we can all participate in the recovery process in a tangible way. A sense that our leaders can uplift the souls of the population and encourage us all to assume an economically assured future.
In Australia there is no such assurance. Here there is an unfortunate paucity of economic thought leadership and this confronts us each day. How often do you hear the question from friends, “how did we end up with these people as our politicians and leaders?”. We suspect it is exactly the same question being asked in places like Ireland, Greece, Italy, Portugal and Spain!
In our view the leadership we have is the result of the apathy and the indifference that came from a sustained period of economic growth that was created by excessive credit. The growth was both real and artificial. It was real because tangible fortunes have been made by a few. It was artificial because it was not sustainable. It created apathy and indifference because in its early period all of us appeared to be better off. It felt like a new economic dawn where we appeared to have achieved a better standard of living that was affordable due to easy credit. Better still, there was no need to lift productivity. We could all be paid more and we deserved it because we needed to service our debt to maintain our standard of living. Accessing and then servicing debt was our fundamental right and our employer was obliged to pay our increased costs of living. If not, then our politicians could be relied upon, because they needed to keep us happy to gather our votes.
So as the curtains come down on the debt charade of the last 15 years there are now serious questions and tests being put to our political and our business leaders. Their responses will set the scene for economic environment in 2012/13. The answers will stimulate or stymie markets and they will affect or support individual businesses.
Why will the questions be asked? Simply because we have hit the debt brick wall and the emergence of the overwhelming power of the new communication medium called the internet. The connectivity of people now allows communities to instantly and widely communicate. Its power is potent and dangerous. It is potent if people can drive change which is beneficial to communities. It is dangerous when dynamic thought leaders abuse the internet for ulterior motives. Both negative and positive sentiment can be wildly distributed through the net!
So we now have a quandary as investors. We appear to be in or heading towards an economic quagmire and there are so many opinions which are garnished with negative predictions. There is a massive appetite for change developing, but nothing is on offer. There is a growing perception that things aren’t sustainable, but many governments are broke and fiscally cannot deliver change. Those that can (i.e. Australia) seem dominated by individuals who are more concerned with maintaining power than doing anything with it.
The difficult world economic outlook is also creating a real test for our business leaders and their current responses are somewhat disheartening. We are seeing businesses beginning to address costs in response to clear signs of slowing economic and credit growth. The initial response of the leaders of banks, financiers and retailers is to retrench labour. From an owners perspective this may be justified as it supposedly holds profits. However, if service industries en masse decide to cut employment then, what will be the economic result? Will profits really be sustained with lower employment and thus consumption? What do our political leaders have to say about these developments? What is their plan? Is there a better alternative?
A cursory review of published and internet editorials of recent weeks as these events unfold, shows a glaring gap in both the business response and the political review. The gap is obvious and uncomfortable for our business leaders. In our view the reduction of business costs must begin at the top of a business. Simply the CEO’s and Boards of businesses, who now perceive that economic difficulty requires a cost adjustment, must start with their own costs. Indeed many of the costs that reside at the top of major companies are the legacy of the debt era. It was a time where mediocre managers looked brilliant. However, it was due to the debt environment rather than their skill base.
By setting an example at the top then maybe the whole of an organisation and the community may follow. We question as to why this has this not even been contemplated and why our politicians have not focused on this. Is it not a widely held community view that executive salaries are wildly excessive? Is it not abundantly obvious that many businesses that grew with the credit binge from 1995 – 2005 have simply faltered in the last seven years? Worse still, the shareholders (which are in the main large public super funds) of many listed and large companies have seen their capital diminish even as business leaders meticulously achieved continuous pay increases. Too often these increases seem to have been based on a perceived right rather than an achieved outcome.
Let us explore this further by doing a simple analysis of major companies today and in 2005. What dividends were paid in calendar 2011 and how does this compare to 2005? This may give us an insight into which companies have suspect business models. It may also identify those companies where executives have been well rewarded for producing mediocre or poor returns. Finally, it may confirm our thoughts that good businesses will over time produce increasing returns to their owners.
Why the comparison to 2005? Well the share market today is trading at the same price index level as 2005. Thus, index investors have achieved no capital gains in this period and have totally relied on their returns to have been derived from dividends.
We have split our reviewed companies into the Good, the Average and the Bad.
The Good
BHP dividend in 2005 was 36.3 cents fully franked (ff) and last year it paid 98 cents (ff). BHP has not undertaken a DRP and it has had two significant buy backs. That is clearly a good outcome and the current outlook is positive. It remains a fundamental part of a value portfolio.
CBA paid $1.97 (ff) in 2005 and lifted this to $3.20 in 2011. A DRP was utilised in 2005 and shareholders reinvested at $36.00. That is a good growing return but the outlook is now for lower growth for the next year. It is a company that is worth owning but the entry point for buyers should be yield focused at say 7% franked.
WBC paid $1.00 (ff) in 2005 and this grew to $1.56 in 2011. That is similar dividend growth to CBA and we suspect it would have been much faster had WBC not acquired St George Bank in 2008. A DRP at $22 in 2005 has produced no capital gain for those participating shareholders. The outlook is for low growth in the coming year. Again a buy price at a yield of 7% franked seems appropriate.
WOW paid 51 cents in 2005 (ff) and has lifted this to $1.22 in 2011. That is very impressive for a supposedly low growth company! WOW had a DRP in 2005 at $15.70 and that has rewarded participating shareholders. Since then WOW has undertaken buybacks and sailed through the GFC. The outlook is for more steady growth. Definitely a core portfolio holding managed by superior executives.
ORL is a great recovery story from 2004. In 2005 the dividend was 12.5 cents (ff) and in 2011 it was 50 cents. ORL has not raised capital in the intervening period. No need for a DRP and shareholders have a received a steady flow of growing income. With Asia rolling out the outlook looks good.
MMS is another company who has steadily raised dividends with no capital raisings until the recent employee option exercise. In 2005 a dividend of 4 cents (ff) was paid and in 2011, this grew to 50 cents. A tremendous rate of compounding cashflow to shareholders! We expect more growth in 2012 and this is one company whose executives have deserved their rewards.
MND probably rates as the best of the best in terms of dividend growth without requiring shareholders to reinvest. Dividends have grown from 19.25 cents (ff) in 2005 to 95 cents in 2011. This is astronomical growth and has not needed to be supported by a DRP at anytime. With the resources boom continuing there is clear evidence that this well managed company has more growth ahead – plus senior management are major shareholders.
The Average
ANZ rates behind the other majors (above) based on dividend growth. In 2005 $1.10 (ff) was paid and lifted to $1.40 in 2011. A DRP at $22.50 in 2005 has been followed by successive raisings. ANZ now has a growth profile in Asia which will need to be successful to compensate long term shareholders for a mediocre return.
DJS is now in a quandary after a successful business recovery in the last 10 years. Dividends paid in 2005 were 13 cents (ff) and these lifted to 28 cents in 2011. That’s impressive but the recent downgrade and the impact of the Internet suggests that dividends are about to decline from here.
NAB paid $1.66 in 2005 and grew this to just $1.72 in 2011. In 2005 NAB issued DRP shares at $32.00 and those who took that reinvestment opportunity have been poorly treated. Here is the worst of the big 4 on any measure and shareholders should rightly question the growth of remuneration packages for it’s senior executives.
QBE paid 63 cents (partly franked) in 2005 and grew these to $1.28 last year. However, a rapid expansion to the US and successive capital raisings have seen ROE tumble and dividends become un-franked. The recent downgrade will see dividends reduced and more offshore acquisitions await shareholders. A DRP of $14.80 in 2005 is now below water. QBE is the best of a bad bunch of insurance investments but, do we really need to own any of them?
TLS actually paid 40 cents (ff) to shareholders in 2005. This was the contrived special payouts that allowed the government to divest more shares through T3. Since then dividends have been rock solid at 28 cents. The recent share price recovery is only partially recouping the falls of the previous 6 years. But positively there has been no capital raised and a steady cashflow to shareholders. The outlook is reasonable should the NBN ever be sanctioned by the ACCC. Telstra is now managed by executives who are paid substantially less then the American dream team whose main focus was on selling the government’s shares.
The Bad
FXJ has been a disaster for shareholders and the outlook remains poor. Dividends have declined from 23.5 cents (ff) in 2005 to just 3 cents last year. Do you remember the $4.59 DRP in 2005? The current outlook does not look any better.
BLD has managed to deliver declining dividends as well as a declining share price. Dividends were 34 cents (ff) in 2005 and just 14.5 cents last year. The $8.60 DRP of 2005 must send shudders down the spine of the poor souls who took it up!
IAG (the former NRMA) is a telling example of why a successful and community focused mutual should never have become a public company. In 2005 a DRP at $5.40 was undertaken to support dividends of 26.5 cents (ff). Last year dividends continued there decline to just 16 cents. Insurance companies remain great places for employees but owner returns are less predictable.
SUN has been a shocker for shareholders. This bank assurance company has never delivered the much touted promises supporting a succession of acquisitions. 2005 saw a dividend of $1.47 (ff) supported by a DRP at $19.40. Last year the dividend fell to just 35 cents and investors must surely question a to why any insurance company should be regarded as a sensible long term investment.
MQG has always been lucrative for executives but now is a poor investment for long term shareholders. In the boom times of 2005, a dividend of $2.30 (90% franked) was paid and shareholders were invited to reinvest their dividend at $60. In 2011 the un-franked dividend dropped to $1.65. This followed massive capital raisings in recent years and a rapidly declining ROE.
QAN has taken its dividend rate down from 19 cents (ff) in 2005 to nothing over the last two years. Meanwhile the executives have negotiated higher salaries and have not been seen to be buyers of their shares despite their desired MBO in 2005! The message is simple for investors – look elsewhere.
WES dividend has fallen from $1.45 (ff) in 2005 to $1.35 (ff) in FY11, a 6.9% decline. This is despite a tripling in net operating cash flows and the businesses equity base now being 9 times larger. NROE is a third of 2005 levels as a result of the large capital raising to acquire Coles in 2007. However, the MD’s (although he is admittedly different to the MD of ’05) performance package is now worth twice as much as then. Again it seems that management remuneration is not adequately tied to shareholder returns.
Conclusion
The above shows that business performance and thus shareholder returns are wildly divergent across the market. The growing levels of executive salaries seem unrelated to business performance as some executives of BAD performers get paid consistently more (relative to market capitalisation) then those at GOOD performers.
Further, investors must and are sensibly becoming more focused on dividend growth as a major means of achieving satisfactory returns from the share market. Thus, executives and boards must be clearly given the message that steady business growth is preferable to growth by acquisitions or the reinvestment of capital into businesses at sub optimal returns on equity.
It is our view that the folly of short term remuneration packages based on total shareholder or relative shareholder returns has been exposed as another means by which wealth is transferred from the many to a few.
Thus, remuneration packages based on shareholder returns are clearly important but:
They can only be assessed on a long term basis of at least 5 years and probably more likely over ten years; and
Relative returns against an index or peer group should be junked. The proxy of outperforming a poor performing peer group is a receipt for mediocrity and the world has way too much of that at present.
Finally, it may now be time for a national business summit hosted by the Prime Minister. President Obama this week set an agenda for businesses to bring jobs back to the US. Our Prime Minister needs to set an agenda whereby our businesses do not lose jobs for Australia.
