Should you ignore Genworth Mortgage Insurance Australia’s 10% yield?

Income investors rejoice! You don’t have to go digging at the small end of the market to find a stock with a 10% dividend yield when you have Genworth Mortgage Insurance Australia (ASX: GMA).

However, the stock isn’t without risks and analysts are divided on whether the yield is enough of an inducement to jump into the stock even though the $1.5 billion market cap’s distribution is around 40% above what the Big Banks are expected to pay in 2018.

The macro drivers for our nation’s mortgage lenders like Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) aren’t too different to Genworth’s.

If you think that the big banks are worth backing, then Genworth should be part of your portfolio mix even though it has greater exposure to the resource focused states of Western Australia and Queensland.

However, resources are bouncing back and employment is expected to remain firm in 2018. The risk of rising claims to the lenders mortgage insurance provider seems reasonably well contained in my view.

The other issue is the company’s recent trading update, which prompted analysts to downgrade their earnings forecasts as Genworth is recognising earnings from its insurance products over a longer period of time.

What this means is that earnings in 2017 and 2018 (its financial year is the same as the calendar year) will fall from the year before the respective periods.

The bigger question is whether 2018 will mark the bottom of the earnings decline and I don’t think you will find much consensus on this front even though most will agree that any further drop in profit will be relatively mild compared to 2017.

The good news is that the earnings decline is unlikely to impact much on the forecast dividend for the company with most analysts pencilling in a dividend of around 25 cents a share in 2017 and around 22 cents in 2018 and beyond.

This puts the stock on a yield of around 10.3% if franking dividends are included for 2018 with the stock easing 1% to $3.03 in morning trade.

I am underweight on the Big Banks and this is unlikely to change in the first half of 2018, but income investors who are more upbeat about the outlook for the sector should look at Genworth as it is probably worth adding to the investment mix given that the market is well aware of the downside risks outlined above.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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