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Should you turn down AGL’s (ASX:AGL) 7% dividend yield?

Turning down AGL shares represented by man placing hands up in front of him and frowning
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The AGL Energy Limited (ASX: AGL) share price has not been a solid performer as of late. At the time of writing, AGL shares are trading for just $13.54. We haven’t seen the market assign such a low price to this power company since December 2014. With the energy giant basically sitting at its 52-week low today, is the AGL share price a buy?

Why are AGL shares hated right now?

With the current share price, plus the fact that AGL has fallen more than 50% in value since 2017, I think it’s fair to say AGL shares are pretty much hated by the market right now.

But why? AGL, as a gas and electricity company, should be a pillar of strength for ASX investors, given that these kinds of companies offer enormous certainty for investors in a year full of uncertainty. We all need electricity to work and live, pandemic or no. Many people also need gas for heating and cooking.

Well, all of this is true to an extent. But that doesn’t mean AGL isn’t in trouble right now. In its earnings report for the 2020 financial year, AGL told investors that its profits after tax had dipped 22%. It gets better: AGL also said that it expects things to get worse before they get better in the coming years. No wonder investors hit the sell button!

A silver lining?

But one thing stood out in AGL’s earnings report: its commitment to paying out dividends. Normally, AGL has a ‘payout ratio policy’ for its dividends, meaning it aims to pay out a set proportion of its earnings each year (75% in this case). But given that AGL is not forecasting much in the way of earnings in FY2021 or FY2022, it has given a commitment to investors that it intends to pay out an additional 25% of earnings over FY21 and FY22 in the form of special dividends. In effect, this means AGL will be paying out 100% of its earnings. 

Unfortunately, these dividends won’t be coming with any franking credits attached. AGL is instead focusing on utilising historical tax losses over this time, which won’t generate franking credits. But it hopes to return to paying a franked dividend by FY2023.

So even though AGL is not in a comfortable situation right now, I think the company is virtually guaranteeing that the 98 cents per share that it paid out in 2020 will continue in FY21 and FY22. 

On current pricing, that would give AGL shares a forward dividend yield of 7.24%. 

Foolish takeaway

Personally, I wouldn’t be buying AGL shares today with any expectation of capital growth over the coming 3 to 5 years. Even so, I think AGL is offering a relatively sustainable dividend yield of 7.24%, which would certainly come in handy if dividend income is an important objective of your ASX share portfolio. Thus, I think AGL is a great buy for income investors today (if not for everyone else).

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Returns As of 6th October 2020

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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 Scott Phillips.

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