Shrewd investors need to seriously consider defensive shares. As the world reacts to Covid-19, we are almost certainly headed into recession.
Defensive shares provide services and products that are unavoidable. They are the infrastructure of our society, are non-cyclical and deliver a constant dividend.
They may well lose value along with the rest of the market. But they will remain in business. They will also continue to deliver dividends through a bear cycle.
Speaking frankly, not all of the companies on the ASX today will be standing when all this is over.
Some examples of classic defensive shares include utilities and infrastructure companies, consumer staples and companies in the healthcare sector.
Electrical utilities
Electrical utilities operate within a regulated market, giving them predictable earnings over a 5-year period.
Two strong performing shares in this space include AusNet Services Limited (ASX: AST) and Spark Infrastructure Group (ASX: SKI). Both are very defensive shares; no matter what happens, the electricity will stay on.
AusNet is the nations largest transmission network and has $13 billion worth of assets. The Australian Energy Regulator (AER) regularly ranks the company as one of the country's more productive.
The last time AusNet cost less than this (at the time of writing) was in January of 2017. At the time of writing it is paying a very healthy 50% franked dividend yield of 6.23%
Spark is an infrastructure fund; its current assets are made up of unlisted distribution and transmission networks.
Spark's assets include distribution networks across South Australia and Victoria. In addition, Spark has a 15% stake in the TransGrid transmission network in New South Wales and the Australian Capital Territory. All of these companies are among Australia's most productive electrical utilities, according to the AER.
Spark hasn't been this cheap since 2014. At the time of writing, it is paying an unfranked dividend yield of 8.38%.
Gas utilities
The AGL Energy Limited (ASX: AGL) share price is at a price-to-earnings (P/E) multiple of 11.98 at the time of writing. That is a fair way below its 10-year average P/E of 18.16. In fact, AGL has not been at this price since 2015.
This company has impressed me in recent times due to its ability to walk away from sunk costs when the deal didn't look appealing. It demonstrated growth in its customer base during the H1 report. In addition, it reported reduced churn and reduced customer acquisition costs.
AGL is carrying a high ratio of debt to equity, which is concerning. However, as a defensive share it has predictable earnings and a compound annual growth rate (CAGR) of free cash of around 42%, which is amazing.
At the time of writing, the AGL dividend yield is 6.83%, which is 80% franked.
Foolish takeaway
Utilities are among the most defensive shares on the ASX, largely because regulated markets gives them predictable earnings. Additionally, all evidence from the UK and Australia show that utilities that have been privatised are far more efficient than their government-owned counterparts.
In the months to come, these defensive shares will continue to provide solid dividends while many other shares face hard times.
