I think that defensive ASX shares could be the best way to protect your portfolio.
Businesses with robust business models should hopefully not see much of a hit to their earnings during this COVID-19 period. If the earnings don't fall much then theoretically the share prices shouldn't drop too much compared to a riskier cyclical share.
I believe the best defensive ASX shares are the ones that won't see much of a change in demand for their product or service.
Here are two of the most defensive ASX shares:
Share 1: APA Group (ASX: APA)
APA Group is one of the biggest infrastructure businesses on the ASX.
It owns a vast network of 15,000km of natural gas pipelines around Australia with a presence in every mainland state and the Northern Territory. It also owns or has interests in gas storage facilities, gas-fired power stations and renewable energy generation (wind and solar farms). APA owns, or manages and operates, a portfolio of assets worth more than $21 billion and delivers half the nation's natural gas usage.
APA delivers an essential service for Australia. The nation needs its natural gas.
I think APA is a defensive ASX share because the demand for gas remains robust. The energy infrastructure giant recently said that there hasn't been a material change because of COVID-19. It also has $1.2 billion of available liquidity to get through this period if needed.
The business has grown its distribution every year for a decade and a half. It offers a FY20 distribution yield of 4.4%. The distribution can keep growing because APA funds it from its annual cashflow. That cashflow is growing because APA continues to complete new energy projects.
Share 2: Rural Funds Group (ASX: RFF)
I think Rural Funds is another great defensive ASX share. It's a farmland real estate investment trust (REIT).
COVID-19 caused many other REITs to be sold off. Shopping centres like Scentre Group (ASX: SCG) were hurt as shoppers stayed away and shops were shut. Office property REITs like DEXUS Property Group (ASX: DXS) were sold down as workers stayed home.
But Rural Funds hasn't faced the same problems. Its agricultural tenants continue to grow produce at the farms. Some of its tenants include Olam, Select Harvests Limited (ASX: SHV) and Treasury Wine Estates Ltd (ASX: TWE).
I think Rural Funds is a really good defensive ASX share for several reasons. It has high-quality tenants like the ones I just mentioned. Rural Funds' farms are diversified geographically and by farm type – it owns cattle, cotton, vineyard, almond and macadamia properties.
One of the best reasons to like Rural Funds is that it has a weighted average lease expiry (WALE) of more than 10 years. That means the rental income is locked in for more than a decade.
That rental income is rising as each rental contract has built-in rental indexation. The rental indexation is either a fixed 2.5% increase or linked to CPI inflation, with market reviews. This helps the management of the defensive ASX share forecast that the distribution can grow by 4% per annum. I think that's a good growth rate, it's comfortably higher than inflation.
Another factor helping distribution growth is productivity investing. Rural Funds retains around 20% of its annual cash rental profit. The official term its cash rental profit is 'adjusted funds from operations' (AFFO). Rural Funds re-invests 20% of AFFO into productivity improvements at its farms for its tenants benefit. This increases the value of the farms and grows rental income.
Occasionally the defensive ASX share will acquire a new farm that will add to earnings. It has been focusing on buying cattle properties in the last couple of years.
It currently offers a FY21 distribution yield of 5.7%.
Foolish takeaway
I think both businesses are defensive ASX shares. At the current prices I'm more drawn to Rural Funds because of its consistent growth and higher distribution yield. However, I'd be happy to have both businesses in my portfolio for reliable income.
