Investors reliant on income are left with little option but to chase high yield stocks after the Reserve Bank of Australia (RBA) cut Australia's cash rate to a record low of 1.5% in August. Whilst there are a handful of opportunities on the market where yields remain astronomically high such as Countplus Ltd (ASX: CUP) and Monadelphous Group Limited (ASX: MND), the problem with these stocks is that the yield appears unsustainable from ongoing operations.
In fact, where businesses offer predictable earnings, like infrastructure companies Transurban Group (ASX: TCL) and Sydney Airport Holdings Ltd (ASX: SYD), the market rewards them by pushing their share prices to historic highs (and yields to all-time lows). Accordingly, income reliant investors aren't left with much option but to turn to the banks for reliable income.
Australia and New Zealand Banking Group (ASX: ANZ) is my pick of the bunch for investors seeking a stable income stream. Here is why.
Big 4 banks
It's no secret that each of ANZ, Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) rate in the top quartile of bank stocks based on every metric. One of their most coveted attributes is their dividend yield.
With the benefit of Australia's imputation system, ANZ, CBA, NAB and Westpac all provide gross yields of between 8.5% to 10.3% (after tax credits) to Australian resident shareholders. Of course, the biggest question for investors is whether this payout can be maintained, given industry headwinds.
Industry headwinds
Australia's banking sector is facing new challenges as a slowdown in mining, rising property market and global deflation pressures margins, whilst increasing the risk profile of domestic banks.
With Australia's banking regulator – APRA – already alert to widespread systematic risks, it has required each of the big 4 banks to hold more capital buffers to make them "unquestionably strong".
Of course, holding more capital takes its toll on bank returns, with all of the big four reporting decreases to their return on equity ratios.
CBA's full-year result in August embodied this trend as Australia's biggest bank reported a 170 basis point drop to its industry leading return on equity percentage. The other majors are expected to report similar reductions when they release full-year results later this year.
As such, bank profitability is likely to decrease. This implies that dividends are also set to be cut.
Why ANZ?
With the above caveats in mind, I believe ANZ represents the best value proposition for income-focused investors. Although ANZ has one of the lowest trailing yields of the big four, trading at around 6% at current prices, investors must remember that it has already cut its dividend to "manageable" levels.
Unlike CBA, NAB and Westpac who haven't cut their dividends (yet), ANZ's management acknowledges the likelihood of slowing profit growth and has planned to lower its payout ratio from the current 75% to 60%-65% in the next few years. In my mind, this payout ratio should be achievable without cutting the dividend further, given the bank continues to grow profit.
Foolish takeaway
Although the other three big banks might provide a higher trailing yield at current prices, I do not believe they can maintain their high yields given industry headwinds. As such, ANZ remains my pick of the big banks for income stability.
