The search for yield

While the European Central Bank reduced eurozone interest rates last summer on two occasions and in January 2015 announced a quantitative easing programme that will commence next month, two other major central banks have different circumstances to deal with.

The Bank of England was mulling a first interest rate hike during 2015 but recent economic data suggests that this may be postponed until 2016. On the other hand, the Federal Reserve still seems to be on target to announce an interest rate hike in 2015 although the exact timing is subject to wide debate due to recent currency movements (the strength of the US dollar) and other geo-political developments.

Whatever the timing of the upcoming interest rate rises in the US and the UK and eventually also in the eurozone, one thing seems probable: when interest rates do rise, the pace of increase will be slower than expected and official interest rates will stabilise at a lower level than during the pre-crisis years seen earlier this decade.

The recent movements in the bond markets indicate that this new norm is being factored in as yields across the globe declined to levels which were unimaginable until a few months ago. The value of long-dated bonds is primarily driven by expectations of inflation and the sharp rally in prices of sovereign bonds during the first few weeks of this year, following from an exceptional performance in 2014, indicates that investors believe interest rates are set to remain low over the long term in spite of aggressive central bank policy. It was probably unthinkable that 10-year yields in the US, UK and eurozone would drop to 1.381 per cent, 1.337 per cent and 0.297 per cent respectively. This was also reflected in Malta with the yield on a 10-year Malta Government Stock dropping to below 1.5 per cent from 2.74 per cent in June 2014.

Corporate bond markets also moved very much in line with the sovereign bond market with an upward movement in prices and corresponding decline in yields. This was also evident in many of the local corporate bonds especially the longer-dated bonds issued during 2014. By way of example, the 6 per cent AX Investments plc 2024 bond rallied to a high of 109.54 per cent, the 6 per cent Medserv plc 2020/23 to 110 per cent and the 5.3 per cent Mariner Finance plc 2024 to 109 per cent.

Corporate bond markets also moved very much in line with sovereign bond market

This phenomenon is also slowly filtering through the equity market as investors turn to shares for a better yield. While this trend in global equity markets has been well documented in the international financial press, it is becoming increasingly evident in Malta too. In fact, three property sector companies with a business model that can produce sustainable dividends were among the best performing equities in 2014. It may be surprising to many that the share prices of Malita Investments plc, Tigné Mall plc and Plaza Centres plc climbed by 20.8 per cent, 16.5 per cent and 13 per cent respectively in 2014, with most of these gains taking place in the second half of the year – incidentally as the European Central Bank announced further declines in interest rates and as speculation of a possible quantitative easing programme started to gather momentum.

This trend continued during the first few weeks of 2015 with all three equities also performing strongly. The rationale for the strong upturn in these share prices in recent months is very possibly due to a spillover of demand from the bond market by investors searching for higher yielding securities. Due to the inverse relationship between prices and yields, as share prices or bond prices rise, yields decline.

As a result, the gross dividend yields of Malita Investments plc and Plaza Centres plc based on the last traded prices have now declined to 4.9 per cent and 5.2 per cent respectively from 6.4 per cent and 6.2 per cent on 30 June 2014. The yield displayed on our website and other publications is based on the dividend distributed in respect of the 2013 financial year since the 2014 full-year results and relative dividend payment recommendations for approval at the annual general meeting have not yet been published. The yields published are gross of tax and investors need to factor in the tax at source (which in most cases is 35 per cent) versus 15 per cent final withholding tax for bonds.

The Tigné Mall plc yield of 2.8 per cent is also based on the dividends declared in respect of the 2013 financial year. However this yield is misleading because the company’s shares were admitted to the Official List of the MSE in May 2013 and only the final dividend is reflected for 2013.

The company also pays an interim dividend. In fact, an interim dividend was declared in August 2014 covering the financial performance for the first half of the year. Therefore, if one adds the final dividend of 2013 and the interim dividend of 2014, the gross dividend yield based on the last traded price of €0.67 rises to 4.3 per cent.

At the time of the Initial Public Offering in the first half of 2013, Tigné Mall had published its financial forecasts and cash flow projections. Should the company achieve its projections and the directors maintain the indicated dividend policy as intimated in their most recent Interim Directors’ Statement of November 6, 2014, the gross dividend yield should soon surpass the 5 per cent level and rise further in 2016 and 2017.

The hunt for yield is also possibly the reason behind the positive upturn in other equities. The 12 per cent rally in the share price of Maltapost plc during the first few weeks of 2015 to a new all-time high of €1.345 could also be the result of the attractive dividend yield of the company when compared to the strong decline in yields across the bond market.

The September 2014 financial results of the postal operator revealed a 37.6 per cent increase in pre-tax profits and a continued strong cash flow generation. The postal operator continues to enjoy a very strong balance sheet with sizeable cash holdings and no debt. These factors could imply that the company can easily continue to sustain its net dividend payout of €0.04 per share despite the ongoing challenges across the postal sector. This should continue to lend support to the equity going forward especially since yields are expected to remain low in the foreseeable future.

Likewise, retail and institutional investors may also be viewing Malta International Airport plc and Go plc more from a dividend perspective rather than primarily for potential capital growth. Although the gross dividend yields of both companies are not as attractive as those of the property sector companies, recent announcements from both companies indicate that they will be reporting positive financial performances for 2014. This could also result in improved dividends to shareholders.

In the banking sector, the share prices of the two large retail banks are also indicating a level of support following a disappointing 2014 with HSBC Bank Malta plc up 3.1 per cent and Bank of Valletta plc edging 1.3 per cent higher since the year-end.

Demand from investors seeking dividend income could also be spilling over into these two equities although the recently introduced regulatory constraints imposed upon the banks before recommending the payment of dividends as opposed to other companies with little or no regulation must not be overlooked.

The publication of the financial statements of HSBC Bank Malta plc on February 23 marks the start of the financial reporting season.

Meanwhile, other companies that have so far failed to generate sustainable and attractive dividends over the years may also be viewed more positively in the future if their dividend policy changes and their financial performances justify the payment of regular dividends to shareholders.

In the light of the current interest rate environment, company dividend policies will undoubtedly be scrutinised in more detail by retail and institutional investors in the upcoming reporting season.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.

Sign up to our free newsletters