Coronavirus: Why Asian equities merit a closer look when seeking income today?
While the coronavirus pandemic has put the world on edge and undoubtedly will change much, one thing which remains consistent and top of investors’ minds is where to find income.
The crisis has witnessed central banks take decisive action – the Federal Reserve has cut US interest rates to almost zero and many policymakers are effectively capping long-dated bond yields through asset-buying programmes.
As a result, government bond yields have dropped significantly - following what has happened in Japan and Europe, US Treasuries saw their own yields move into negative territory for the first time.
Equity investors join the income hunt
At the same time, the potential loss of traditional equity income has deepened investors’ worries as many European and US banks – historically a significant source of dividend income – have had to cut their dividend payments under regulatory pressures.
Given this unusual backdrop, a diversification towards Asia as a source of equity income has arguably become potentially even more compelling than it already was prior to the pandemic.
Although Asian companies are also facing the possibility of dividend cuts due to decline in earnings, there hasn’t been strong government intervention in most Asian markets thus far and regulators appear generally more focused on capital management.
In fact, following the dividend cancellation announced by some banks with a strong Asian presence, the Hong Kong Monetary Authority assured that it did not require local lenders to suspend dividend payments as the local banking sector was well capitalised. In Korea, for its part, the National Pension Scheme (NPS) has even urged a number of retail giants to increase their dividends.
Asia’s rising dividends
While still in its infancy relative to developed markets, Asia has become an increasingly important source of the world’s equity income as the dividend culture has been picking up steadily with a strong performance over the past decade. Until 2018, the Asia Pacific ex. Japan region enjoyed the fastest 10-year growth rate in dividend payouts versus any region globally (Exhibit 1). While 2019 saw payouts fall slightly due to the slower pace of global economic growth and the impact of trade tensions, on an underlying basis, dividends from the region have risen 124% in the past 10 years as of end of 2019. As Asian companies have demonstrated a specific fixation on payout ratios (Exhibit 2), weaker profitability translates quickly into dividends.
Asian equities in a good place with stronger finances
Though the likelihood of corporate dividend cuts is global, Asian momentum has potentially never been better as companies are better prepared to support dividends given large cash balances and low gearing levels this time round than during the global financial crisis in 2008. Data provided by Jefferies shows that about 20% of market cap in Asia ex. Japan is backed by cash, significantly above both Europe (at around 9.7%) and the US (about 6.3%) – see Exhibits 3 and 4. According to a Nomura analysis, 48% of top 100 non-financial Chinese/Hong Hong firms are net cash firms, with cash levels exceeding debt, while in the US and UK this is only 18% and 21% respectively.
Source: Jefferies, Mar 2020. NDE = net debt to equity %
Furthermore, valuations for Asia ex. Japan equities still appear relatively attractive, particularly on a price-to-book basis, compared to both their own history and to the rest of the world. With their strong balance sheets, positive cash flows and relatively low pay-out ratios, Asian corporates are overall well positioned. In our view, they are more likely – and more able - to raise pay-outs or use other forms of capital management after they recover from the coronavirus hit.
As such, we continue to see significant opportunity for investors to access income in Asia even as bond yields globally remain close to historical lows. Moreover, even if companies maintain pay-out ratios at their current relatively subdued levels, Asian growth means that the region should be able to provide investors with a rising income stream over time.
Where can investors potentially find opportunities in Asia?
As of December 2019, financial and technology companies are the biggest contributors to dividend in major economies in Asia ex Japan. Compared with 2008, China financials have tripled their dividend share and overtook Taiwan tech as the top contributor (Exhibit 5). Nevertheless, the latter market continues to be a major source of equity income, given its well-established dividend-paying culture.
Despite headline growth momentum slowing in the first quarter due to the coronavirus outbreak, Chinese equities have demonstrated resilience relative to global markets and could potentially continue to offer attractive opportunities in 2020.
Meanwhile, the regulatory pressure for Chinese large-cap companies on cutting dividends has been largely nonexistent, if not reversed, as the biggest Chinese dividend stocks are state-owned enterprises (SOEs). Beijing has just transferred around 1.1 trillion yuan-worth of shares in SOEs to the national social security fund in 2019, as part of efforts to avoid a pension shortfall as the country ages. Since SOE dividends are the national social security fund’s main source of funding, the Chinese government has been driving corporates to keep improving their dividend policies.
Asian equity potentially offers a quality space for income alternatives
Overall, in our view Asian equities are likely to weather the demand for dividend cuts better than other markets throughout the coronavirus crisis, with strong balance sheets underpinning a decent income potential. Meanwhile, from a longer-term perspective, we believe the coronavirus outbreak is unlikely to derail the secular growth story in Asia. It is supported by structural drivers including favourable demographics, the expanding middle class and greater urbanisation - which we feel will continue to present attractive long-term investment opportunities. We believe that the Asian growth story, together with the recent drop in valuations, have created attractive opportunities in Asian equities space that could be a reliable alternative for income-seekers.