Woolworths shows why not all yields are created equal

If they didn’t already, investors in Woolworths, BHP Billiton and ANZ Bank now know that not all yields are created equal. After a host of dividend cuts, these shareholders are keenly aware that rental-supported yield is more stable than that paid from corporate earnings.

For income-focused investors, understanding how the yield is generated is just as important as its apparent size. There are two main reasons why distributions from rental payments are different from dividends paid from corporate profits.

First, rental payments are a legally binding, contractual obligation. In the same way that rent on your house falls due whether you are gainfully employed or not, a company cannot escape its rental obligations, regardless of whether it makes a profit or not.

Second, whilst a company’s sales and expenses fluctuate, rental contracts typically stipulate a steady but inevitable increase over the contract’s term. Whether a company makes or loses money has no impact on its legal obligation to pay rent but may well impact its decision to pay dividends. Dividends can change rapidly: rents tend to rise slowly over the life of a rental contract.

Because the payment of rental expenses ahead of dividends is both a contractual and operational priority, Australian Real Estate Investment Trusts (AREITs), which effectively collect this rent, offer a higher level of security of return than the dividends derived from corporate earnings.

Indeed – like interest payments on any debt that a business has, the rent must be paid, otherwise, like the lender to a business – the landlord can enforce its rights under the lease contract.

A corporate prioritises the payment of operating costs, including rental expenses, prior to the assessment of net earnings. If a company fails to make a profit it’s unlikely to declare a dividend but it must still pay the rent.

This point has been well made by Woolworths recently. With its supermarkets facing increased competition and margin pressure, in February the company posted a first half loss of $972.7m, its first in two decades, driven by a writedown in Masters. The divided was slashed by over a third as a result.

How did this affect three AREITs that heavily depend on rental income from Woolworths for their income? The answer: hardly at all.

ALE Property Group (ASX.LEP) owns 86 hospitality properties with a total value of almost $1bn. Its entire portfolio is leased to ALH, 75% owned by Woolworths. The 2016 result showed rental income rising 2% and distributions up about 19%.

It was much the same story at SCA Property Group (ASX.SCP), owner of 81 Australasian shopping centres. Almost half its gross rental income is derived from Woolworths but its most recent half year results showed rental growth of over 5% p.a. and distributions rising 7.1%.

Growthpoint Properties (ASX.GOZ), owner of 57 office and industrial properties, generates 22% of rental income from Woolworths. Its recent half year to December 2015 saw distributions 4.1% higher than in the previous corresponding period.

The pattern is obvious and illustrated in the chart below. Comparing Woolworths half-yearly dividend payments over the past 5 years with distributions from the three AREITs mentioned above highlights the relative stability of AREIT distributions.

 

Dividend payments

 
The recent history is even more revealing. Each AREIT has continued to deliver strong dividend growth despite challenging operating conditions and a dividend cut from one of its key tenants. That’s why investors that want secure, stable returns prefer AREITs. Woolworths’ recent history makes that point perfectly.

 


This article has been prepared by APN Funds Management Limited (ACN 080 674 479, AFSL No. 237500) for general information purposes only and without taking your objectives, financial situation or needs into account. You should consider these matters and read the product disclosure statement (PDS) for each of the funds described in this article in its entirety before you make an investment decision. The PDS contains important information about risks, costs and fees associated with an investment in the relevant fund. For a copy of the PDS and more details about a fund and its performance click here. To receive further updates and insights from the APN team, sign up for Review, our monthly email newsletter.