Subdued economic conditions coupled with historically low interest rates will continue to fuel the search for income investments. However, it appears that recent developments may be shifting investor interest away from one of the best bets for high yield over the last several years – the Big Four Banks.
Slowing growth at the Big Four (meaning lower dividends) is the big concern. We have heard this story before and the banks have surprised, but there are mounting headwinds that could morph into a full-fledged perfect storm.
Shareholders have seen the value of their holdings diluted due to capital raises needed to meet higher regulatory capital requirements; there may be more to come. The most recent round of financial releases showed healthy profits for all of the Big Four, but the average ROE (Return on Equity) across all four dropped from 15.5% to 15%. Net Interest Margins (NIM) – a measure of a bank’s cost of interest paid out on deposits and interest collected from loans – are falling. But as the following chart shows, NIM has been falling for almost five years while bank profits continue at record or near record levels.
The already fierce competition in the consumer loan market is about to get tougher, and not from the increasing market share going to the big regional banks, but from within the ranks of the Big Four. ANZ’s new CEO intends to scale back on the Asian strategy (introduced and pursued by his predecessor) and look to grab market share in Australia instead.
Share prices have tumbled over the last three months – down some 18% at ANZ; 13% at CBA; 10% at Westpac (WBC) and close to 18% at NAB.
If you believe bank dividends may suffer over the long term, you should look for alternatives. But where?
We began with stock screener searches for ASX stocks with current fully franked dividend yields greater than 5%, and less than 15%, to avoid stocks with outlandish yields due to huge drops in price. We noted the predominant sector in the list was Diversified Financials, and within that group it appeared the majority of stocks were managed funds of one kind or another.
Our idea here is to look for the least risky stocks in the group and given the condition of global share markets we chose to look elsewhere. We found three stocks with high yields and a solid track record of dividend performance and reasonable growth estimates. Any high yielding alternative to the Big Four needs to have a comparable history of dividend payments. The following table looks at each company’s share price, earnings, dividend performance, and expected growth. Here is the table.
FlexiGroup (FXL) and Money 3 (MNY) are both classified as Credit Services Providers while Thorn Group (TGA) is classified as a Commercial Services Provider, although the company does operate in some financial areas. In fact, Thorn Group describes itself as a “leading Australian provider of financial services.”
The company began in the radio rental business 80 years ago, expanding to include other consumer electronic offerings. Thorn launched a pilot online rental service in the Brisbane area in 2014, scheduled for a major review at the end of 2016 with an eye towards further expansion. The company also provides a variety of equipment leases for business and government agencies, with a focus on Small to Medium Enterprises (SME).
In the past few years Thorn has made a concerted effort to expand what it does, entering the field of financial services. Thorn Financial Services offers unsecured loans between $1,000 and $5,000 through Cashfirst and larger loans (15k to 25k) through Thorn Money. In 2011 Thorn got into the receivables management business with the acquisition of NCML (National Credit Management Limited). The most recent acquisition was Cash Resources Australia which serves businesses in need of short term funding.
Adding revenue streams not dependent solely on consumer appetites has moved Thorn into similar businesses of the two more successful companies in our table – FlexiGroup and Money 3. Thorn’s Full Year Financial Results for 2015 were released in July, showing a 25% increase in revenue and a 9.6% increase in net profit. In the past few months the company has come under fire for the interest rates charged for rentals to some consumers and the share price has suffered. Thorn Group has a trailing twelve month (TTM) P/E of 10.44 with a Forward P/E of 8.15 and an admirable 5 Year Expected P/EG ratio of 0.78.
FlexiGroup was created in 1988 to provide financing for office equipment for the SME segment. By 1995 the company had partnered with retailer Harvey Norman (HVN) with FlexiRent which provided for consumer rentals, expanding again with FlexiWay to include home appliances and more electronics. FlexiGroup also has equipment leasing programs for small businesses and larger enterprises and an exclusive consumer leasing arrangement with leading retailer JB Hi Fi (JBH) called SmartWay.
The company also offers broadband and mobile phones to consumers and interest free and no interest loans to consumers. Consumer offerings include a range of debit and interest free credit cards. FlexiGroup shareholders have been plagued by leadership changes this year but the company’s aggressive acquisition efforts soothed the investor community. The company has been looking to dramatically increase its presence in New Zealand, thrilling investors with the news it had acquired New Zealand Based Fisher & Paykel Finance. Here is a chart showing market reaction.
FXL has a trailing twelve month P/E of 11.24 and a Forward P/E of 9.52. The average P/E for the Diversified Financials Sector is 16.42.
Money 3 (MNP) offers financing solutions to the “credit challenged.” The company estimates there are 2.65 million Australians without access to traditional loan and credit providers. Money 3 offers unsecured short term cash loans between $100 and $5,000 as well as personal and car loans from $2,000 to $35,000. The company now offers “fast cash” loans online. Money 3 also operates a secured loan division for sub-prime borrowers to finance cars, boats, trucks, and tractors.
Fiscal Year 2015 was the ninth consecutive year Money 3 has shown a profit. Revenues rose 59.5% and net profit after tax was up 78%. Revenue and profit have more than tripled since FY 2013, rising from revenues of $22.7 million to the current $69.4 million with profit jumping from $3.6 million to $13.9 million. The share price kept rolling upward until early in 2015 when the ASIC (Australian Securities and Investment Commission) issued a record fine against a similar lender, the Cash Store, and announced an investigation into the practices of short term loan providers. Investors took notice, although MNY management stated it was not concerned. Here is a 5 year price chart for MNY.
In August Westpac Banking Corporation announced it would no longer provide funds to companies like MNY and rival Cash Converters International (CCI). The company has some big-name defenders who claim Money 3 operates by the rules and has been unfairly “tarnished” by those who don’t. It is worthwhile to note that as of the current month, the analyst consensus rating for MNY is still Outperform with one analyst at Buy and two at Outperform.
One could make a strong case that these three companies are not only the equals of the Big Four Banks when it comes to high yields, they may actually be superior.
First, while the Big Banks are heavily dependent on mortgage loans, the three stocks in our table are more diversified.
Second, surprising as it may seem, they have actually outperformed the Banks over the last five years. The following table includes the same metrics in the earlier table on the Diversified Financial stocks, FXL, MNY, and the oddly classified TGA. Compare the numbers, and you be the judge. Here is the table.