Investors looking for ASX dividends have long benefitted from the rules around franking credits in Australia since they were first introduced in 1987.
With the August earnings season now truly done and dusted, many companies are sitting on large piles of cash, which analysts and investors alike are eyeing very closely.
Brokers have identified several big names in the ASX 200, including Rio Tinto Ltd (ASX: RIO), Ramsay Health Care Ltd (ASX: RHC), JB Hi-Fi Ltd (ASX: JBH), Mineral Resources Ltd (ASX: MIN), and REA Group Ltd (ASX: REA), are sitting on massive piles of excess franking credits.
But what does that mean for shareholders? Let's see what the experts think.
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Franking credits and special dividends
When a company pays ASX dividends, the franking credits attached represent the tax it has already paid on its profits.
That's because the Australian dividend imputation system ensures that these profits aren't taxed twice – once in the company's hands and once in the investors'. Instead, it is just at the company level.
Franking credits can offset shareholders' tax obligations. If an investor's tax rate is lower than the company's (usually 30%), they can even receive a refund.
However, companies can accumulate large amounts of franking credits over time, especially if they don't distribute them regularly through dividends.
Often, when companies find themselves in this situation with no option to reinvest the money internally, they return it to shareholders as a special dividend.
Typically, dividends are recurring and follow a fairly normal pattern of payment, such as every half-year period.
But special dividends are a one-off payout, usually because the business has a sudden influx of surplus cash.
Special dividends also allow companies to distribute accumulated franking credits while still retaining enough capital for reinvestment and growth.
The question is, which companies that pay ASX dividends fit the bill here?
ASX dividends for investors
To this point, Morgan Stanley has been busy on the case, scouring the investment universe of ASX dividends.
The broker has released a report identifying the ASX 200 companies with the largest excess franking credit balances. Morgan Stanley had this to say (as reported in the Australian Financial Review):
The recent result season showed an emerging trend for companies with excess franking credits to start paying special dividends.
We expect this to increase over time given limited options to distribute post rule changes to buybacks and highlight companies with largest balances as a starting point.
Analysts at the firm highlighted Rio Tinto, Ramsay Health Care, JB-Hi Fi, Mineral Resources and REA Group as the top five companies with franking credits higher than their last reported dividend per share.
The broker says these companies have a significant capacity to issue special dividends, should their boards choose to do so.
Meanwhile, Plato Investment Management said the decision to pay a special dividend with franking credits was a little more nuanced. Per the AFR:
[The decision has] still got to be in the context of do they have the cash to pay them out and if they've got a high capex budget.
Woodside Energy Group Ltd (ASX: WDS), for instance, has to reinvest high sums of cash to stay competitive. As such, it "can't really afford" a big jump in dividends, Plato says.
Foolish takeaway
According to Morgan Stanley, the trend of companies paying special ASX dividends to distribute excess franking credits could increase over time.
Time will tell if the broker is correct or not. In the meantime, investors can look to companies with excess franking credits with a positive light.
