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Investors all over the world await the much anticipated first hike in interest rates in the United States.  Here in Australia we are told the RBA is also waiting, believing that rising rates in the US will pressure the AUD towards the desired 75 cent mark without further rate cuts.  

The waiting game continues as the expectation of that first hike coming in June has now been pushed back to September.   The end result of the US Fed’s latest announcement was an upward spike in the AUD to about 78 cents, leading to a swelling number of Aussie investors searching for yield.  One of the chief beneficiaries was perennial dividend powerhouse Commonwealth Bank of Australia (CBA), whose share price rose to record highs.

We are now reading that the RBA may be forced to cut again, fueling the already over-heated fires of high yielding stocks.  Given the record share price, it would appear investors favor the safety of a big blue chip dividend payer like CBA.  Investors wary of the big banks are steered towards another blue chip dividend titan, telecommunications giant Telstra Corporation (TLS).

Some market experts like to remind investors that the total returns of blue chip dividend payers can sometimes trail mid-cap and small-cap dividend payers with superior growth potential.  New investors can be blinded by the glare of a staggering yield and forget that over time what is important is not just the dividend, but the total shareholder return, which includes share price appreciation.  To illustrate, let’s go back in time to August of 2012.

Suppose you were ready to take the plunge into a high dividend stock.  You did some research and found CBA to be the best of the big banks and TLS the stock of choice as an alternative to the big banks.  You uncovered an article highlighting two mid-cap Telco’s with promise.  Here are the dividend yields for Fiscal Year 2012 of the four stocks that made your list:

•    Telstra Corporation Limited (TLS)        7.6%

•    Commonwealth Bank of Australia (CBA)        6.3%

•    M2 Group Limited (MTU)            4.5%

•    TPG Telecom Limited (TPM)            2.8%

You opted to split your investment between TLS and CBA.  It is now late March of 2015.  The following table looks at the average annual rate of total shareholder return and share price appreciation over three years;  two year forward earnings growth forecast; and two year forward dividend growth forecast for each of the four stocks.

CODE

3 Year Total Shareholder Return

Share Price % Appreciation

2 Year Earnings Growth Forecast

2 Year Dividend Growth Forecast

TLS

+32.3%

+94%

-2.2%

+3.7%

CBA

+30.8%

+96%

+7.1%

+6.0%

MTU

+47.9%

+200%

+7.1%

+16.7%

TPM

+74%

+400%

+25.8%

+19.6%

 

Certainly TLS and CBA have outperformed for shareholders; but had you bought the lowest yielding share (TPM) you would have netted the highest return.  TPM is all over the financial pages with the news of its potential acquisition of iiNet Limited (IIN).   Should the takeover get approved TPM would overtake Optus to claim the number two position behind Telstra, and the 2 year forecasts suggest TPM has more room to run, despite its lofty trailing twelve month P/E of around 40. 

We think the scenario we have laid out supports the oft-stated advice not to shop for dividend stocks on the basis of yield alone.  There are a myriad of factors to consider, but some market experts appear to think they all boil down to two overriding issues – is the dividend sustainable and will it grow. 

History provides a clue regarding dividend stability.  The past five years have not been particularly kind to share market investors.  Therefore, it seems only common sense to look for stocks that have outperformed during that period.  Given the demise of the mining boom and the absence of anything certain to replace it, our economic future is somewhat dim.  So again it only seems common sense to look for stocks with positive earnings and dividend growth forecasts over the next two years.  To avoid overpaying, Forward P/E’s under 15 that are below sector average would be ideal.

These are tough criteria and our stock screen pinpointed only five that best fit those standards.  We searched for double digit earnings, revenue, net income, and dividend growth over the last five years.  Then we honed in on those few stocks with positive growth forecasts and reasonable Forward P/E’s.  The following table includes five mid to small cap stocks to consider.

Company

(CODE)

Market Cap

Share Price

(52 Wk % Change)

Dividend Yield

5 Year Growth Rate

Dividends

(Earnings)

Forward P/E

2 Year Growth Forecast

Dividends

(Earnings)

Credit Corp

(CCP)

$499m

$10.81

(+23%)

3.8%

+58.5%

(+25.11%)

11.88

+7.1%

(+10.6%)

Thorn Group

(TGA)

$409m

$2.73

(+30%)

4.2%

+18.4%

(+15%)

11.87

+10.6%

(+11.04%)

Collection House

(CLH)

$303m

$2.33

(+30%)

3.7%

+10.3%

(+15%)

12.86

+11.8%

(+16.8%)

Cedar Woods Properties

(CWP)

$451m

$5.70

(-24%)

4.9%

+31.4%

(+27.2%)

10.0

+4.4%

(+4.2%)

Money3 Corp

(MNY)

$187m

$1.40

(+34%)

3.5%

+37%

(+18.45%)

10.81

+18.3%

(+26.3%)

 

Coincidentally, every company in our table is in some way involved in the business of credit, from providing loans to collecting bad debts to benefiting from lower rates on mortgage loans.  The performance, valuation, and forecast numbers for these stocks across the board are solid, and in some cases outstanding.  Property developer Cedar Woods is the only stock whose share price has fallen year over year, largely due to the company’s substantial presence in the hard-hit regions of Western Australia.  Every stock has a Forward P/E below the average of the sector in which the company operates.  Again with the sole exception of Cedar Woods, every stock has double digit earnings growth forecasts and all have rewarded shareholders with double digit growth in both earnings and dividends over the past five years.  Lower interest rates typically lead to increased credit use so in theory these companies are well positioned for the future.

Credit Corp Group Limited (CCP) joins Cedar Woods as the other stock with a two year dividend growth forecast under 10%.  However, note that CCP’s 7.1% forecast tops that of both Telstra and Commonwealth Bank. 

Credit Corp is the largest debt collector in Australia.  Business customers can either sell debts in collection to Credit Corp or use the company’s Agency Services to assist in debt collection.  Consumers can get debt help through a Credit Corp subsidiary with debt repayment plans.  The company has one location in the US market.  Full Year 2014 and Half Year 2015 results showed across the board double digit increases in revenue, net profit, and earnings per share.  Full Year 2014 dividends were up 8% with a 10% increase for the Half Year 2015.

Collection House Limited (CLH) adds a more robust consumer services business to its debt collection operations.  With CLH consumers can get credit counseling and training.  The company also offers legal and insolvency services.  While the financial results reported by Collection House have also showed hefty increases, there is one factor differentiating them from Credit Corp in the recently reported Half Year results.  The debts these two companies acquire from the direct lenders are called Purchased Debt Ledgers, or PDL’s.  For the Half Year PDL’s at Credit Corp were down 35% while at Collection House, they rose 25%, with CLH management crediting previous investments in improved technology and increased staff for the increase.  Another difference of recent vintage is the entry into direct lending to “credit impaired” consumers at Credit Corp. 

Impressive share price appreciation is common both companies.  Here is a five year price movement chart for the two.

Thorn Group (TGA) is another company that has moved into direct lending to financially strapped consumers.  The Thorn Financial Services Division offers unsecured and secured personal loans.  The company began direct lending in 2010 with its Cashfirst program offering small loans and later debt consolidation loans.  Thorn Money now offers larger loans for car purchases and other needs.

Thorn also arranges funding for equipment leases and purchases for its business clients.  The company began as a renter of radio equipment 80 years ago and the company still leases technology offerings for commercial and consumer use.  Thorn offers Credit Management Services to businesses ranging from managing receivables to debt collection.  Finally, the company recently acquired Cash Resources Australia, a company that offers short term funding to businesses that prefer to avoid over drafting or increasing existing debt facilities from traditional banks.

Despite the fact that the lending industry catering to the needs of consumers who do not have access to traditional banks is heavily regulated, it is not surprising to see companies like Thorn and Credit Corp expanding into this market when you look at the track record of Money3 Corporation (MNY). 

The average annual rate of Total shareholder Return over five years is 39% and 60% over five years.  Half Year 2015 Results included a 67.4% rise in revenue and a 135.72% profit increase. Full Year 2014 Results were equally stunning – a 90% increase in revenue and a 114% increase in profit.  A few days prior to the Half Year Release the MNY share price had risen 70% year over year but has since fallen.  Here is the chart.

 

 

The reaction is somewhat surprising but Money3 management commentary suggested recent media articles casting a negative view on “second tier lenders” were unfounded.  However, investors may have taken that comment and the review of the Consumer Credit Legislation Amendment) Act 2012 coming up in July of 2015 as a sign of more regulation. 

While some might view lending to those who can least afford it as somewhat unsavory, Money3 points out this is a segment of the population with no access to traditional credit.  The company had multiple capital raises in the past year to acquire smaller players and now has close to 70 locations across Australia along with an online presence.  According to Money3 there are 2.65 million Australians without access to credit of any kind.  Analysts tell us that segment of the overall credit market is small, but has grown more than 100% since 2008.  Money3 started as a payday lender and has moved up to a broader range of loans, secured and unsecured, up to $20,000.

Finally, there is award winning developer Cedar Woods Property (CWP).  The recently released Half Year 2015 Results were troubling with a 23% revenue decline and a 55% drop in profit.  Full Year 2014 Results reported back in August showed increases in both revenue and profit but the company warned that Half Year 2015 results would be down due to project timing and settlements.  Investors apparently focused on the negative forward guidance as the stock price began to decline.  Here is the chart.

Management increased its full year guidance during the Half Year Results presentation, but had only positive things to say about the market in Western Australia.  Others aren’t so sure, as the chief of the Stockland Property Group recently commented that the market in WA was slowing. 

Check the reporting statements from Cedar Woods and you will find little hard evidence of a major problem in the holdings in Western Australia at this time.  The analyst consensus rating on CWP is a Buy.  Money3 Corporation is the only other stock in the table with a consensus Buy recommendation.

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