With interest rates falling in recent years, the challenge of generating a decent income from investments has become increasingly difficult. Certainly, the amount of interest earned on cash balances may still be just ahead of inflation but, realistically, with the Aussie economy set to experience a highly challenging period, the chances are that the RBA will cut rates further.
As a result, many investors are turning to stocks to plug the gap made by disappointing returns on cash balances. And, with property rental income often not covering the cost of paying a mortgage and maintaining a property, buying high-quality ASX stocks appears to be the best option available to income-seekers.
However, with a recession for the Aussie economy becoming increasingly likely, how safe are dividends at some of the highest yielding stocks on the ASX? Could dividend cuts be on the cards due to major falls in profitability?
On the face of it, BHP Billiton Limited's (ASX: BHP) yield of 7.3% is astounding. It is easily ahead of the ASX's yield of 4.8% and, best of all, it is fully franked. The problem, though, is that BHP cannot afford to pay out its current level of dividends in perpetuity since they amount to more than annual profit.
For example, in the current year BHP is forecast to deliver $0.59 in earnings per share and yet is expected to pay out around $1.75 in dividends per share. Similarly, next year BHP's bottom line is due to rise by an impressive 35%, but this still leaves it well short of being able to afford its dividend.
Clearly, BHP is able to make such high levels of dividend payments in the short run, but for investors seeking long-term stability in dividends, it may be best to assume that BHP will slash its dividends unless profit soars. This means that its yield could prove to be rather less than 7.3% over the medium term.
Similarly, shopping centre operator Scentre Group Ltd (ASX: SCG) is also very generous when it comes to shareholder payouts. It currently pays out 93% of profit as a dividend and, with the latter due to rise by 2.9% next year on subdued profit growth, the company's payout ratio could reach as much as 94% next year.
Such a level of payout is sustainable in the short run but, over time, Scentre may need to reinvest a greater proportion of its profit in growth opportunities to further enhance shareholder value. So, while its yield of 5.4% may hold great appeal, with consumer confidence coming under pressure and Australia being forecast to flirt with recession moving forward, its shareholder payouts may be less than anticipated.
Meanwhile, Insurance Australia Group Ltd's (ASX: IAG) dividends appear to be relatively secure at their current levels. Certainly, profit is due to rise by only a very low single digit rate next year, but with the insurance company only paying out a relatively modest 72% of profit as a dividend, it provides it with sufficient capital to reinvest while also maintaining a generous 5.8% yield for its investors.
Furthermore, IAG trades on a price to earnings (P/E) ratio of 13, which is lower than the ASX's P/E ratio of 15.1 and also holds more appeal than the insurance sector's rating of 15.8. And, with IAG having a beta of just 0.6, its shares should offer less volatility than the wider index in the months ahead, which may prove useful if the ASX remains a choppy market.
So, while the likes of BHP and Scentre remain excellent long term buys due to their solid financial standing, sound strategies, and competitive advantages, their dividends may prove to be less solid than those of IAG.
