With interest rates now sitting at 2% and set to move even lower, dividends are becoming an increasingly important aspect of investing for many Australians. And, while there are a number of excellent income stocks on the ASX, some are inevitably more appealing than others.
With that in mind, if you could buy only Telstra Corporation Ltd (ASX: TLS) or Coca-Cola Amatil Ltd (ASX: CCL) for its income potential, which should it be?
Headline Figures
On the face of it, Telstra appears to be a better income prospect than Coca-Cola Amatil. That's because it currently yields 4.9% versus 4.6% for Coca-Cola Amatil, with Telstra's dividends being fully franked, while Coca-Cola's dividends are only partially franked. Furthermore, Telstra has a better track record of increasing dividends per share, with them having risen at an annualised rate of 1% during the last five years, while Coca-Cola Amatil's shareholder payouts have fallen by 0.7% per annum during the same time period.
In addition, Coca-Cola is going through a challenging period. For example, it is currently in the process of cutting costs, making its business more efficient and also battling against uncertain demand amidst a tough economic backdrop. And, while Telstra may be facing the same challenges regarding the domestic economy, it has been able to grow its bottom line at a steady clip of 2.9% per annum during the last five years, which shows that it has been a relatively defensive and resilient business.
The Turnaround
However, Coca-Cola Amatil's headline figures do not paint the full picture, since its major turnaround plan is set to produce bottom line growth in the current financial year, with net profit forecast to rise by 5.4% per annum during the next two years. This should allow Coca-Cola to increase its dividends but also maintain its healthy dividend coverage ratio of 1.2 times. And, with expansion into the potentially lucrative Indonesian market offering the prospects of even greater growth, the outlook for a brisk dividend increase seems to be very real.
Meanwhile, Telstra's target to derive 33% of its profit from Asia by 2020 also indicates that its bottom line should rise at a faster rate over the medium to long term than is currently forecast for the next two years. In fact, Telstra's bottom line is set to fall at an annualised rate of 1.4% during the next two years, and this could put dividends under a degree of pressure. That's because, in the current year, Telstra's dividends are set to be covered just 1.1 times by profit.
While this is sufficient in the short run to allow reinvestment in the business, Telstra seems to have less scope for dividend rises than Coca-Cola Amatil, owing to its lower near-term growth rate and lower dividend coverage ratio.
Defensive Businesses?
Clearly, Telstra and Coca-Cola Amatil have reputations as being relatively defensive stocks, as evidenced by their betas of just 0.5. This means that their shares should change in valuation by just 0.5% for every 1% move in the price level of the wider index.
However, with major expansion plans in Asia and uncertainty in their domestic market, the outlook for both companies remains less stable than many investors believe. As such, their futures may be less certain than is currently being priced in (they both trade on price to earnings (P/E) ratios of 18).
Nonetheless, they remain top-notch income plays and, as a result of its higher dividend coverage ratio, better near-term growth prospects and scope for further efficiencies as its strategy begins to take hold, Coca-Cola appears to be the preferred option if you can only buy one or the other right now.
