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Immunising one’s investment portfolio

1Q2013 ended with good gains for most investors. The FTSTI surged to flirt with the key resistance of 3,300 while my life-long recommendation to continue to adopt a High Dividend Stock Investing strategy (HDS), have continued to outperform the FTSTI.

One interesting investment concept that I learned during my Chartered Financial Analyst (CFA) days was that investors should look to immuninise one’s portfolio after a good market run. It piques me that few dare to talk or conceptualize this concept even though we are bombarded by daily interviews with analysts and fund managers over CNBC, Bloomberg TV, RT TV etc. Is this concept so necessary but difficult that many would not dare conceptualise it in detail or is it an elusive one?

To me, immunization one’s investment portfolio helps to protect the returns. One need not be too smart, but to act on the key guidance from companies to yield continual “safer” returns via dividends as some business models do throw up good free cash flows that can return gradual but increasing dividends to shareholders.

Free Cash flows or FCF is a measure of how a company earns its hard cash less capital expenditure.

Thus, FCF = Operating Cash Flow – Capital Expenditure

For high yield stocks, I reckon that FCF is a better base figure to use rather than Net Profits as dividends are paid out from cashflows although most investment reports use Net Profits as the base.

FCF is also a better foundation to understand and pick companies with good cashflow generation rate rather than just companies with good profit growth rates which the stockmarket tend to over emphasize. Investors should look out for companies that deliver strong profit growth rates, but shareholders do not partake it its profit growth if its cashflow do not allow for dividend distribution.

Essentially, a company’s cashflow is essentially utilized for:

  1. Capital Expenditure to maintain the level of operating efficiency
  2. Pay off debts n thereby lower its gearing
  3. For payment as dividends to shareholders
  4. For profit retention

A key favourite of mine is the Singapore Telecom sector.

The telecom industry is marked by high barriers to entry as it entail high fixed costs investments for data cables, sub-sea cables, licences fees, base station costs etc.

It is a regulated industry where interesting, all the 3 telecom companies, Singtel, Starhub and M1 are directly or indirectly owned by the government.

As these companies have been operating for many years, economies of scales have kicked in at this phase of their economic cycles in the various markets they operate in. For the past few years for now, capex for these telecom companies have remained low and stable as compared to their Operating Cashflows which mean they throw out almost consistent FCF available for dividends distribution year after year.

It is in this context that Singtel’s management continue to guide that they will undertake capital restructuring, another term, that investors take it to mean as special dividend payment, every 3 years.

As these companies have been operating for many years, economies of scales have kicked in at this phase of their economic cycles in the various markets they operate in. For the past few years for now, capex for these telecom companies have remained low and stable as compared to their Operating Cashflows which mean they throw out almost consistent FCF available for dividends distribution year after year.

It is in this context that Singtel’s management continue to guide that they will undertake capital restructuring, another term, that investors take it to mean as special dividend payment, every 3 years.

Based on issued shares of 15.86 billion and 25.8 cts DPS, total dividends required a cash outlay of almost $4.1 billion. Singtel’s FY2011 and FY2012 net profits were $3.82 billion and $3.99 billion respectively.

Supposed we assume a share base of 16 billion shares and maximum payout of 70% Net Profits as Dividend payout, total dividends can be $2.8 billin or 17.5 cts per share. This would translate to an attractive yield of 5.15% based on current share price of $3.40. This is the yield I would get while waiting for the next special dividends without even recognizing possible capital gains on the share price.

Looking more in-depth into Singtel’s FCF which averaged $3.25 billion in the past 3 years, Total Cashflows could add up to $1.35 billion (FY2012 cash balance) + $3.25 billion (conservatively projected for FY2013) + $3.25 billion (conservatively projected for FY2014) = $7.85 billion!

After less off our assumed maximum 70% payout in both years of $2.8 billion for each year or a total of $5.6 billion, proforma Singtel’s net cash balance at FY2014 could amount to $7.85 billion - $5.6 billion = $2.25 billion.

Assuming that management is comfortable with current cash balance of $1.35 billion, net surplus available for the next special dividend payout could be $2.25 billion - $1.35 billion = $900 million or 5.6 cts DPS.

Thus, Singtel can still afford to pay a special dividend in FY2014 EVEN if it pays out maximum 70% of Net Profits as normal dividends to shareholders in the current and next year! This makes Singtel a very good stock to help immunize one’s investment portfolio going forward.

So while many view Singtel as a “no growth mature” stock, I view Singtel as a very good defensive stock which generates tremendous FCF. Singtel was the earliest telco listed in 1993. However, in the last decade, it has withstood 2 major bear markets, namely the post 2000 Y2K/Dot.com bubble and the 2008 Financial Crisis very well, looking at its FCF and Net Profit profile of the past decade. Net profit did fall, but by at most 21% YOY in FY2001. In the recent Financial Crisis, net profit fall was only 13% to $3.25 billion in FY2009. Few stocks in Singapore or Asia would be able to match such profile.

Thus, investors looking to immuninise the portfolio can consider Singtel as a good template with the various characteristics highlighted, to look for other stocks. Who says good old companies are boring? They are exciting to me as they generate boring stable Cashflows which allow me to plan and finance my exciting lifestyle, if I indeed choose this option. :)

Gabriel Yap
Gabriel Yap

Mr Gabriel Yap,CFA was an eminent stockbroker who retired from stockbroking in 2009 to devote himself to philanthropy to help the needy, poor and handicap globally. He has donated and assisted Charities Aid Foundation, Australia (CAF), a not-for-profit donor funds management business. CAF has granted over A$100 million in the past decade to needy organisations to undertake aid and charity work across the world.

Mr Yap is also Executive Chairman of GCP Global Pte Ltd, an investment firm that invest in both direct capital markets, bonds, real estate, commodities, foreign exchange and builds businesses. Mr Yap appears regularly for the TV media like Channel News Asia and Bloomberg and radio channels like FM93.8 for their various investment programs.

Previously Mr Yap has also lectured at renowned government institutions like the SEASEN Course for the Monetary Authority of Singapore and at Asian Development Bank. Mr Yap has also lectured at financial institutions like the Stock Exchange of Singapore, Institute of Banking and Finance, the Institute of Certified Public Accountants, the Singapore Institute of Management and the Securities Investors Association of Singapore.

In 2010, the venerable Reader’s Digest magazine created the Money Savvy column in their magazine, helmed by Mr Yap who writes on all things finance and answers questions from the magazine’s subscribers.

Mr Yap presently splits his time between Melbourne, Hong Kong/China and Singapore.