ASX dividend shares can provide investors with attractive, predictable passive income. But what factors influence how consistent those payments can be?
Some of the biggest companies known for paying dividends, such as BHP Group Ltd (ASX: BHP) and Rio Tinto Ltd (ASX: RIO) have seen very volatile payouts over the last eight years. A business like APA Group (ASX: APA) has grown its distribution every year for close to 20 years.
Investors Mutual Limited, or IML, has outlined some of the things to look for in businesses to achieve consistent dividends. They suggest that high-quality industrial companies tend to pay the most consistent payments over time and "offer the best chance of consistent income to fund your lifestyle while still growing your initial capital over time".
IML likes dividends because they're "more reliable than capital growth, are less volatile, and tend to perform better during times of low economic growth". As well, they're "likely to return the lion's share of returns for the next decade".
Let's look at three factors IML thinks are important.
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Recurring earnings
Looking for profit consistency is one of the factors of IML's investment philosophy because recurring earnings make a company more predictable. Those businesses are also "unlikely to suffer from the same booms and busts as cyclical companies".
The fund manager's Michael O'Neill pointed to ASX share Wesfarmers Ltd (ASX: WES) with its Bunnings business as an example. He said:
Putting valuation aside, a good example of this is Wesfarmers, particularly the Bunnings franchise, which represents around 70% of its valuation. Bunnings is a very high-quality franchise which continues to go from strength to strength, generating strong, and increasing, cash flow. It is dominant in its industry and has become a part of popular culture and embedded in its communities with its DIY mentality, motivated staff and beloved sausage sizzles.
It continues to grow its earnings and dividends by rolling out more stores, broadening its product range, and improving its margins. The overall Wesfarmers dividend has benefited greatly from the Bunnings growth engine, and Coles Group Ltd (ASX: COL) which was demerged in late 2018.
Capable management
Having a great management team is a "key feature", according to IML. I'll note that while the management team usually isn't working directly in the mines or shops, it is entrusted to make important decisions for the business. It is the captain of the ship, so sometimes it needs to make tough choices or come up with smart turnaround tactics to achieve long-term returns.
IML's O'Neill pointed to ASX share Brambles Limited (ASX: BXB) as having great management:
A prime example of this is Brambles, a long-term holding of ours where we think management has done a stellar job. The current CEO, Graham Chipchase, has been in the role since early 2017 and his team has significantly improved the profitability of the business over that time as well as reduced earnings volatility. The CEO is well supported by the Brambles board, led by John Mullen as Chair. Mullen has a strong history of leadership in logistics as well as a distinguished board career, and has helped to drive a strong culture of continuous improvement.
One example of these improvements can be seen in Brambles' Americas division, which was the poorest performing division when Chipchase joined the company. Chipchase and his management team put in place a series of measures to improve margins and the overall revenue it earned per pallet in the Americas.
Brambles' success since Chipchase started in 2017 can be seen in the consistent growth of its pallet pool over the last six years as well as its underlying earnings before interest, tax, depreciation and amortisation (EBITDA) margin expanding by approximately 4% over this period.
Re-investing profits for growth
The third factor that IML is wanting to see with dividend-paying ASX shares is that they are re-investing profits.
The fund manager doesn't want to see companies stretch their balance sheets, or pay too large dividends because it can lead to weak earnings growth and/or unsustainable dividends.
Two ASX share examples that O'Neill referred to here were Sonic Healthcare Ltd (ASX: SHL) and Amcor (ASX: AMC).
The fund manager noted that Sonic has retained around 30% of its earnings to fund growth, and spent that either on capital expenditure or acquisitions.
Amcor has also retained around 30% of its earnings over the years to afford bolt-on acquisitions, while also raising equity to acquire businesses like Alcan from Rio Tinto in 2009 and Bemis in 2019. These acquisitions "were very successful, transforming the business and driving further growth", IML said.
