investing in asia - dividend...
TRANSCRIPT
Investing in Asia – Dividend Matters……………………………………………………………………….…. 03
Section I : Dividend Investing
Long and successful history ............................................................................................................... 04
Making a comeback............................................................................................................................ 06
Section II : Investment Opportunities in Asia
Growing and consolidating.................................................................................................................. 08
Companies have higher propensity to pay dividends ........................................................................ 10
Robust Asian growth is supportive of higher dividends...................................................................... 11
Section III : Valuation and Risks
Favourable valuations......................................................................................................................... 13
Risks................................................................................................................................................... 13
Conclusion………………………………………………………………………………………………………. 15
2
TABLE OF CONTENTS
1 Our thought piece “Investing in Asia – The Next 10 Years” argued for the investment case for Asian equities. We reiterate
some of the arguments in the third section of this white paper.
Investing in Asia – Dividend Matters
Dividend investing is a long proven strategy which is making a strong
comeback globally after a hiatus of half a century. Our conjecture is that
dividends will once again be highly coveted in the „new normal‟ world.
Dividend investing is new to Asia but is catching on rapidly. Historically a
dividend culture was rather underdeveloped in Asia. The financial crisis of
1998 sparked a series of changes in corporate behavior, including that towards
dividends. A dividend culture has been taking root and consolidating. And local
investors are increasingly drawn to dividend investing.
Successful dividend investing relies on companies delivering sustainable and
growing dividends. Growth in dividends in the long run depends on growth in
earnings. Some of the best opportunities for investing in companies with
growing income and dividends are likely to be found in Asia over the next
decade or two.1
THOUGHT
LEADERSHIP
SERIES
3
Chart 1: Economic centre of the world is shifting back to Asia
0%
20%
40%
60%
80%
100%
1820 1870 1913 1950 1973 2001 2015F 2025F
% of World GDP at PPP
China India Japan United States Big 4 European Rest of World
Source : Angus Maddison and OECD
Ashish Goyal
Investment Director
2 The history of the Dutch East India Company (Dutch: Vereenigde Oost-Indische Compagnie, VOC) is a fascinating storyabout the immense success and the subsequent decline of the world‟s first listed multinational corporation over 200 yearsof changing political, economic, and trade conditions during the 17th and the 18th century. It is highly recommendedreading for the student of economic and corporate history.
Section I Dividend Investing
Since the dawn of stock markets, dividends
have played a very important role in delivering
returns to investors.
The first ever listed company was the Dutch East
India Company established in 1602. It ran a very
successful spice trading business and paid an 18%
annual dividend for nearly 200 years.2 As stock
markets grew, inevitably they went through
speculative periods where stock prices lost any
rational relationship with underlying economics. In
these periods, dividends became less important.
Speculative investing has a nasty habit of
penalising investors when the bubble bursts or the
excessive valuation deflates. Dividends tend to
reassert themselves in these post speculative
periods.
Since the 1950’s, ‘growth investing’ has
dominated investor psyche and ‘dividend
investing’ has taken a back-seat.
These past 5-6 decades have been an extraordinary
period of economic and stock market growth. During
this growth period, companies have reduced their
payout ratios and chosen to reinvest capital
pursuing growth.
From the charts below it can be seen how there was
a distinct shift away from dividends in the US from
around the mid-50‟s as companies cut their payout
ratios by 10 to 20 percentage points.
Long and successful history
4
Chart 2: Dividend contribution has fallen since 1950s…..... Chart 3: ......as payouts declined
Source: Morgan Stanley, *Data is percentage share of 15-year
returns due to dividends. The share exceeds 100% when
equity prices have fallen over the 15 year period. May 2013
Source: Morgan Stanley, Data based on 10-year average
earnings and dividends, May 2013
20
40
60
80
100
18801890190019101920193019401950196019701980199020002010
US Payout Ratio, %
0
20
40
60
80
100
1890190019101920193019401950196019701980199020002010
Dividend Share as a % of Total Equity Return* in US
3 Recently there have been several examples of the stock market rewarding capital management initiatives. In
April, Woodside Petroleum in Australia announced an increase in dividends. The stock promptly leapt 12% over the next
two days, pressurising other companies to follow the same path.
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3
8
13
18
-5
5
15
25
35
1995 1998 2000 2002 2004 2006 2008 2010 2012
Earnings per share (LHS) Dividend per share (RHS)
However we are now staring at a prolonged
period of low growth. In the next decade or two
opportunities for growth will be far more limited.
After an initial period of building cash on the balance
sheet, companies will come to the conclusion that
they need to rethink use of their capital. Institutional
ownership of stocks has increased and companies
are under enormous pressure to payout all the
capital they cannot justify retaining.3 Either through
buy-backs or through higher payout ratios, they
need to return more of their earnings to investors.
Dividend investing does well for a number of
reasons. Dividend investing is a proxy for or a
variant of „value investing‟. In the long run, „value
investing‟ has triumphed as a style. Similarly
dividend investing has worked very well for
investors. Not only are the returns competitive with
other styles of investing, there are other
characteristics which make the strategy interesting
to a large body of investors.
Dividends tend to be more stable than earnings.
Companies use dividends to signal the health of
their business. They are very reluctant to cut
dividends in the face of temporary business
downturns. They will raise dividends when the
outlook for the future looks bright and the
confidence
5
Chart 4: Dividends are more stable than earnings
Source: MSCI Asia Pacific ex Jpn, Bloomberg, April 2013
in growing earnings is high. Dividends have a
“certainty” that an investor can rely on. This is very
different from the “promise” or “hope” of growth that
is offered by companies reluctant to pay out
dividends because they see themselves as „growth‟
companies. In fact it is quite common for erstwhile
„growth‟ companies to refuse to pay dividends
because they worry that the market will now see
them as „ex-growth‟ companies. These companies
will often build up massive cash piles on their
balance sheet or make expensive acquisitions to try
to generate growth. In either case they destroy a lot
of shareholder value.
Studies have shown that companies with a high
dividend payout ratio have higher future
earnings growth. This is very counter-intuitive.
One would expect companies that retain more
capital to grow faster than companies that payout
high dividends. However empirical evidence
debunks this. Chart 5 shows the findings from a
study that looked at earnings growth of companies
with different payout ratios. The study found that
companies which had a higher payout ratio had
better earnings growth. I suspect that a strong focus
on capital discipline by high dividend paying
companies is what drives this positive outcome for
investors.
Chart 5: High payout companies grow faster
Source: Financial Analysts Journal, Robert Arnott and Clifford
Asness
4 One is reminded of Einstein‟s quote about compound interest being the eighth wonder of the world. Dividends have the
same wonderful quality of compounding.
3.9%4.8%
2.3%
3.1%
0%
2%
4%
6%
8%
MSCI World MSCI Asia Pacific ex Jpn
Price Return Dividend
Dividends may sound boring but they are
anything but. Dividends accumulate year in and
year out and tend to compound quietly and
efficiently.4 The long term history of dividends
shows that more than a third of the total return (and
as much as 50% depending on the period chosen)
from equities comes from dividends.
Dividends have become particularly interesting
in an environment where investment returns will
be more difficult to generate. Cash and bonds
have little chance of delivering strong real
returns over the next few years.
Interest rates have fallen to extraordinary low levels
which would be consistent with very low growth
deflationary outcomes (see chart 7). Any signs of
normalization will be very problematic for bonds.
Using empirical data (see chart 8) we can see that
any normalization suggests negative real returns on
10 year treasuries over the next decade.
6
Chart 7: Interest rates at all time lows
Source: *refers to US, Eurozone, Japan, UK, Canada. GDP-
PPP weights, Bloomberg. May 2013
Making a comeback
Equities, on the other hand, have a better shot
at delivering real returns to investors. However
that depends on a number of factors such as
earnings growth coming through and valuation
levels in the new normal world. The unfortunate
truth is that over the next two decades investment
returns from most assets are likely to be poor. Not
only that, macroeconomic settings suggest elevated
risk levels and increasing probability of “black swan”
events.
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8
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
G7 10 Year Interest Rates*, %
Chart 8: Low yields suggestpoor prospectivereal returns
Source: *refers to real total return for Treasury market, monthly
data from 1926, Bloomberg. May 2013
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-5
0
5
10
15
0 2 4 6 8 10 12 14 16
10 year Treasury yield
10 year real total return*
US Treasury yield
is here currently
Chart 6: Dividends make up ~ 40% of returns since 1988
Source: RIMES, IBES, Morgan Stanley Research, May 2013
39%
37%
5 Buying any overpriced asset is unlikely to make for a rewarding investment. Dividend stocks are not immune to this
economic reality.7
It is hence no surprise that investors in the
recent past have migrated aggressively to
income strategies. Having exhausted the return
potential of government bonds, corporate
bonds, and high yield corporate bonds, they are
increasingly turning to dividend stocks. Even
investors who have historically invested in equities
for growth are showing a preference for the
"certainty of dividends" over the "promise of
growth".
We believe this trend is still in its early stages.
There is a risk that dividend stocks might become
overvalued at some stage in the next few years. We
are not there yet. Even if we do get to a “dividend
bubble” phase5, I believe that the interest in dividend
investing is likely to be enduring.
Ageing populations in the more developed Asian
economies and in China will further boost the
demand for income generating assets.
Irrespective of whether dividend stocks get cyclically
overpriced or not, structurally the interest in dividend
investing is likely to remain much higher than has
been in the last 50 years. The strategy will remain
relevant and may once again be the dominant way
investors invest in equities in the “new normal”
world.
Section II Investment Opportunities In Asia
20 years ago as a rookie investor when I went
around Asia interviewing company management, a
section of questions on my checklist would be
around dividends. What was the dividend strategy of
the company? Did they plan to progressively
increase dividends? How did the company balance
the need to retain capital for reinvestment versus
dividends? How high did they set the investment
hurdle rates for growth capital expenditure?
This was all classic investment theory I had learnt at
business school. The real world in Asia behaved
very differently. The responses varied from a hearty
laugh to a commiserative sigh. The suggestion from
both was that I was asking all the wrong
questions, that dividends didn‟t matter, and that I
didn‟t really understand investing in Asia.
Clearly Asia in the early 90’s did not have a
dividend culture. Corporate Asia was very growth
focused. Underdeveloped capital markets meant
that growth had to be funded heavily with retained
profits. However the lack of a dividend culture also
meant that in many instances there was a lack of
capital discipline. This was very visible in the boom
of the early to mid-90s when companies frequently
invested their surpluses on unrelated businesses
(typically a real estate development) or trophy
assets (golf courses).
Towards the end phase of that bull
market, companies were raising money in short-
term, un-hedged US$ debt and using this money to
invest for growth or their pet projects. This was a big
contributory factor to the Asian financial crisis of
1998.
The Asian crisis of 1998 made a deep and lasting
impression on corporate Asia, changing behavior
quite dramatically. Companies responded in three
stages.
In the first stage, the banking sector and the
corporate sector repaired balance sheets.
Companies reduced their debt levels. Currency
exposures were reined in. Tenure of borrowing was
extended. Balance sheet strength was rebuilt.
Growing and Consolidating
8
Chart 9: Corporate Asia has repaired its balance sheet
Source: MSCI Asia ex Jpn,Datastream, UBS
estimates, December 2012
0%
20%
40%
60%
80%
1988199019921994199619982000200220042006200820102012
Net Debt to Equity Ratio, %
6 Taiwan tax rules encourage companies to aggressively pay out dividends. However, most companies in Taiwan have
highly cyclical businesses and hence dividends tend to be of a “constant payout” nature rather than “progressive”. The
dividends mimic the cyclicality of underlying earnings.
Similarly banks retreated to more conservative
standards of lending and reduced their aggressive
loan to deposit ratios (LDRs) from well over 100% to
well under.
9
Finally companies have embraced shareholder
friendly capital management. Excess cash on
balance sheets is increasingly being used to either
buy back shares or to raise dividends. Naturally
progress is more visible in some markets than
others. Local tax rules have meant quirkiness in
how some markets behave.6 Institutional and
professional investors now expect companies to
make explicit commitments around use of cash. The
dividends section of my question list is no longer
laughed at. Interestingly, despite higher growth
prospects, and hence the need for higher retained
earnings, Asian equity markets have some of the
highest payouts and dividend yields in the world.
In the second stage the focus has been on
capital discipline which has significantly improved.
Increasingly we hear of clearly articulated and
sensibly high hurdle rates for pursuing new projects.
Non-core businesses have been hived off or
restructured. Management KPIs have changed from
pursuing growth to pursuing profitable growth. This
is very visible in the rising return on equity (ROE) of
corporate Asia.
Chart 12: Healthy payout ratios from corporate Asia
Source: MSCI and Bernstein Analysis, May 2013
20%
30%
40%
50%
60%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Payout ratio
Asia Pacific (ex Jpn) United States
Chart 11: Asian profitability has improved
Source: Datrastream, April 2013
Return on equity %
Asia ex Japan World
94 96 98 00 02 04 06 08 10 124
6
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Chart 13: Asia Pac ex Japan offers a higher yield than US
Source: MSCI and Bernstein Analysis, May 2013
0.5%
1.5%
2.5%
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4.5%
5.5%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Dividend yield
Asia Pacific (ex Jpn) United States
Chart 10: Asian (ex Japan) banks are in good shape
Source: CEIC, UBS Estimates, January 2013
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110%
1995 1998 2001 2004 2007 2010 2013
Loans as % of deposit ratio
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1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Fraction of companies that pay a dividend vs regional universe
Asia Pacific (ex Jpn) United States
Thanks to the change in corporate behavior
towards dividends, Asia now has a wide and
deep pool of dividend paying listed companies.
The Asia ex-Japan listed universe has
approximately 1,250 companies with a market
capitalization of over $1 billion. Of these, about 850
trade more than US$ 3 million per day on average.
This constitutes our broadest definition of the
investible universe. Our narrowed down list consists
of about 320 companies that have a dividend yield
of over 3%.
Within this list there are about 120 companies that
have delivered an annualized growth rate of 10% in
dividends over the last 5 years. This is our focus list.
10
Companies in Asia-Pacific have a higher propensity to pay dividends
At Eastspring Investments we run a large and
very successful dividend strategy.
Our equity income strategies invests across Asia
Pacific ex Japan, focusing on total returns from
companies that pay out a reasonable dividend.
Dividend sustainability, dividend growth, a strong
minority shareholder orientation and good valuation
are all essential criteria before we buy a company.
The strategies hold about 60 to 70 names – these
are the companies which we have bought after
conducting in-depth research and analysis. We find
that increasingly it is possible to construct a well
diversified, yield oriented equity strategy in Asia.
This would not have been easy 20 years ago.
Source: MSCI and Bernstein Analysis, May 2013
Chart 14: Companies in Asia Pacific have a higher
propensity to pay dividends
I expect slow global economic growth for a
prolonged period of time, possibly a
decade, perhaps two decades. Asian economic
growth will be significantly higher than the rest of the
world as has been the case for the last decade.7
11
Robust Asian growth is supportive of higher dividends
7 There is significant and robust academic material dismissing the value of this excess growth. Their conclusion is that there is no correlationbetween high economic growth and stock market returns. In fact some studies have even shown a negative correlation. It is my contentionthat these studies have framed the question in a way that is not helpful to investors. There are several links to the transmission fromeconomic growth to stock market returns and only a full and complete understanding of the linkages can help investors navigate equitymarkets. For a full commentary on this subject our readers will have to wait for my next piece “Growth Matters”. In the interim let me leaveyou with a simple idea that growth is valuable. Ceteris paribus, higher growth will equal higher stock market returns. However, since all thingsare never equal, and since my paper won‟t be written for a while, I will counsel readers in the interim to watch the most critical variable forinvesting, which is valuation. Starting valuation matters immensely and is more important than growth prospects. I comment on this inSectionIII of this paper.8 China‟s outgoing premier Wen Jiabao has repeatedly used the words "unbalanced, uncoordinated and unsustainable" to describe China‟sgrowth. As China slows there will be dislocations in the corporate sector and there will be winners and losers. The system as a whole shouldsurviveand it will be our task as equity investors to identify the winners and invest with them.
There are many drivers of this higher growth.
Demographics are highly favorable in several
emerging Asian markets. This is great for
consumption growth. Urbanization and
industrialization are making steady progress. These
trends are very good for investment activity. Exports
used to be very important. The importance has
diminished to some extent and is increasingly driven
by intra-Asia trade, which is a good development.
Hence slowdown in developed markets has less of
an impact for Asia. Savings rates remain
high, supporting the funding required for this growth.
National balance sheets are in much better
shape than developed markets, giving policy
makers much more flexibility to manage cycles and
focus on structural transitions that many markets
are going through. Not all the structural changes are
positive for growth. For example, China‟s economic
restructuring can only be pursued if they choose to
target a much slower growth rate than has been the
case for the last two decades.8
The short term macroeconomic challenges in
Asia are cyclical and can be adequately dealt
with through monetary and fiscal response. The
medium term macroeconomic challenges of Asia
are in most instances quite distinct from those of
developed markets. The challenges mostly deal with
structural reforms that allow the migration from low-
income to middle-income and then from middle-
income to developed status.
Most Asian citizens have few retirement and
healthcare benefit entitlements. Hence the state
does not carry the heavy liabilities as in developed
markets. This is an important distinction. It gives
policy makers the time and the flexibility to shape
policy optimally.
-8
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1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Global Asia ex Jpn G10
Real GDP, Qtr %
Source: Morgan Stanley, GDP(no PPP adjustment), March
2013
Chart 15: Asia grows faster than rest of the world
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1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Sovereign Debt as a % of GDP*
G7 Advanced economies Emerging and developing economies
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2007 2008 2009 2010 2011 2012
Share of Industry Smartphone Profits
Apple Samsung
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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
US$ bn
Brand Value (LHS) Brand Rank (RHS)
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Chart 16: Public sectordebt is a developed-worldproblem
However the most exciting story in Asia is at the
micro level. Investors have to recognize that
corporate Asia today is very different from the
corporate Asia I was quizzing about dividends 20
years ago. Asian companies have acquired some
critical attributes that were missing.
Companies in Asia have acquired scale and
hence enjoy cost structures and market positions
that allow them to compete globally. They are
much better managed today with professionals
running the helm. It is quite common today for
companies to find the best talent available globally
to run businesses or projects in Asia. They have
invested and continue to invest heavily in
intellectual property creation (read research and
development expenses) and brand building.
Corporate governance practices and minority
shareholder focus has dramatically improved. It
can always get better but the trends are
unmistakably positive. As a result investors can now
invest in a large collection of companies that are
showing exciting prospects of local and global
success. It is no surprise that flows to Asia continue
to grow. Many global investors are underinvested in
Asia and are actively trying to correct this
positioning.
Chart 17: From market share to profit share
Source: Gartner, IDC, and Strategy Analytics historical and
company data; Jefferies estimates, Jan 2013
Chart 18: Samsung’s meteoric rise in brand value and rank
Source: Interbrand, 2012
For an Asian equity dividend investor, there is a
vast choice of high quality companies to choose
from. These are companies with low leverage and
GDP+ earnings growth. Dividends from these
companies are sustainable and will grow - features
that we really value when investing in dividend
paying companies in our highly successful Asian
equity income strategy.
The fiscal situation in most Asian markets is
reasonable. Unlike several advanced
economies, there is less risk of corporate tax rates
being increased, or worse, taxes on dividends either
being levied (several markets have no dividend
taxes) or increased.
Source: Morgan Stanley, *Data based on average using GDP-
PPP weights, IMF Forecasts, May 2013
Sovereign Debt as a % of GDP*
-30%
-10%
10%
30%
50%
0.5 1.0 1.5 2.0 2.5 3.0
Historical P/B
P/B on 10 June 2013 is 1.55x
Implied 3 year return = 11%
Section III Valuations and Risks
No discussion about investments can ever be
complete without discussing valuation and risks. We
believe that valuation is the starting point for all
investments. And investments are best made after
fully understanding the risks associated.
Intuitively, it is quite easy to grasp the idea that
buying into the stock market when valuation is
inexpensive should lead to superior investment
returns. We can also show this empirically. Chart 19
shows the distribution of subsequent 3 years
annualised returns given different starting points.
Since our last missive written in August 2012, Asian
equities have delivered a 5% return. Almost all of
that has been from earnings growth and dividends.
The market valuation is unchanged at 1.55 times
price to book (P/B). History suggests that from
current levels of valuation, we can expect attractive
returns in the medium term.
The investment case is even more compelling when
one compares dividend yields on an Asian equity
income strategy with cash and bond yields.
Valuations are favourable
13
Chart 19 : Valuation matters most
Source: MSCI Asia ex Jpn, Datastream, April 2013
Remain cognizant of the risks
There are several risks when one invests in Asia.
The top three on my mind (and it is a long laundry
list that I worry about – it comes with the nature of
being a conservative, value-oriented, long-term
investor) are:
Exogenous shocks and correlation risk
Equity markets have been highly correlated for a
while and I will not be surprised if an adverse event
in Europe leads to a sharp correction in Asia.
This will be an opportunity. Watch the valuation and
if Asia gets really cheap that will be the time to
aggressively add to positions.
3 years forward equity returns
vs P/B, annualised (since 1990)
14
China
China needs to transition from an aggressively
investment led economy to one that is more
balanced, more driven by market forces, and more
internally consistent.
This transition is neither easy nor risk-free and will
inevitably mean that China‟s economic growth rate
will slow meaningfully.
The macroeconomic challenges get all the attention
but the real challenge for equity investors like us is
to find the listed companies that can survive or even
thrive in this transition phase and beyond.
There are quite a few companies and some of them
even pay decent dividends. It is these investment
opportunities that we are most focused on.
Politics and Policy missteps
The potential of Asia is immense. However there
are very real challenges in policy making and
execution.
Over the last 6-8 years under the Congress led
government, India has been the poster child of how
not to run an economy.
There has been a lack of leadership and a lack of
progress. Important reforms have stalled and
investment activity has come to a grind.
Reversing this will not be easy and is a reminder of
how growth potential can be frittered away by poor
policy making.
Many Asian economies are young democracies and
are still learning how to deliver high quality
governance and long-range policy making even as
they have to go to polls every 5 years.
The good news is that the average voter seems to
have a strong intuitive sense for what is best for him
and votes accordingly. The pace of progress varies
but the direction does not.
Conclusion
Globally, dividend investing is back and here to
stay.
Asia has joined the Dividend Club. Dividend
investing is new to Asia but is catching on rapidly. A
dividend culture has been taking root and
consolidating. And local investors are increasingly
drawn to dividend investing.
For the global dividend investor, an Asian Dividend
strategy broadens the universe from which to
harvest dividends. It diversifies the portfolio and
introduces some exciting new investment
opportunities to the portfolio.
15
Eastspring Investments has a long and successful
track record of managing an Asian Equity Income
strategy.
Our investors have benefitted immensely from
investing in the Asian dividend story. We remain
optimistic that this will continue to be the case over
the next two decades.
16
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