EWA - EWA: Time To Head To Australia For High Yields

2023-06-05 10:55:58 ET

Summary

• The iShares MSCI Australia ETF offers exposure to Australian stocks with high dividend yields, currently above 6%, making it a suitable addition for income-oriented investors.
• The Australian economy is heavily based on mining and commodities, with major trading partners in Asia, but this comes with risks such as global recession, economic slowdowns, and geopolitical tensions.
• The fund also has exposure to Australia's financial and real estate markets, which have been very strong historically.
• This ETF is suitable for a very specific group of investors who'd like to invest in a high-yielding commodity-based income fund.

iShares MSCI Australia ETF ( EWA ) offers exposure to the largest Australian stocks, and it has a history of offering high dividend yields. The fund currently yields above 6% without using any leverage. I think this could be a good addition to portfolios of income-oriented investors who would like higher yields.

The fund currently holds 67 stocks. While some of these stocks such as BHP Group Limited ( BHP ) already trade in American exchanges, many others either don't trade in proper exchanges or have so little liquidity that bid-ask spread is too wide. This index allows you to just buy a package of Australian stocks without worrying too much about liquidity.

Australian economy is mostly based on mining and commodities. The country produces and exports huge amounts of commodities every year. The vast majority of the country's exports go to Asian countries such as China, Japan, and South Korea that are highly industrialized and in need of commodities to produce things. Australia's main exports include iron core, coal, oil, Liquefied Natural Gas Production, gold, rare metals, copper, silver, lead, and agricultural commodities such as meat and grains.

This comes both with benefits and risks. The biggest benefits include the fact that the country has many willing customers for its products and commodities serve as an inflation protection since their prices tend to rise along with inflation. The biggest risks include a global recession or a slowdown of the economy in Asia. Commodity markets tend to be hit extra hard during recessions and economic slowdowns, but those tend to be temporary. Basically, buying this Australia-based ETF is like buying commodities with a high dividend yield.

There can also be some geopolitical risks involved. China is a huge trading partner for Australia. It happens that China buys more than 30% of all commodities exported by Australia. From time to time, these two countries have political friction and this could lead China to buy less from Australia, but I don't expect things to get there. If things got serious enough that China cuts Australia from its markets, we will have bigger things to worry about since it would mean we are in the midst of a global crisis, in which case it wouldn't make sense to buy most stocks anyways. The two countries experienced some brief tension in 2020 during the COVID-19 pandemic, but things have been improving since then and China continues to buy as much commodity from Australia as it can in order to fuel its industrial growth.

Some of the biggest holdings of EWA are mining stocks such as BHP Group ( BHP ) and Rio Tinto ( RIO ) but there should be no surprises there. The fund also holds some of Australia's largest banks such as Commonwealth Bank of Australia ( CBAUF ) and National Australia Bank ( NABZY ). These banks also do a lot of business with the country's mining industry, so it would be fair to say that they also have a lot of exposure to the country's commodities market.

In addition, large banks in Australia also have a lot of exposure to the country's real estate market. While Australia's population has been growing steadily for the last 50+ years thanks to immigration, the country's entire population is concentrated around 5-6 big cities and this created a real estate bubble in those countries. In some areas, Australian real estate prices rose too fast and too much and if real estate prices were to collapse in the country, this would be a pretty big risk for banks. This issue reminds me of the Canadian economy and Canadian banks, another economy that is mostly based on commodities, has an exceptionally strong real estate market and population growth mostly concentrated around a few big cities, and most of the growth comes from an influx of immigration. One could say that Canadian and Australian economies have a lot in common.

Australian stocks also offer some rare and unusual sectors that are hard to come by in other countries. They have a lottery company called The Lottery Corporation Limited ( LTRCF ) which is also part of this fund and a toll road company called Atlas Arteria ( MAQAF ) which owns toll roads not only in Australia but in other countries as well, including the US. They also have some farming REITs that include growing foods and cattle. All in all, Australian companies have a history of paying rich dividends and enjoying low valuations.

Currently, EWA's holdings have an average P/E ratio of 12 and a price to book ratio of only 2, but there should be no surprises there considering how many of its holdings are mining, financial, energy, and real estate stocks and the fact that those sectors tend to have low valuations. In total, less than 2% of the fund's holdings are tech stocks.

As I said before, this fund should be mostly considered as a commodities-based income play. It currently yields about 6%, and it has a history of paying high dividends, even though dividend payments changed from year to year. Notice that the fund's dividend payment dropped significantly in 2020 because the global commodity market was in turmoil during that year due to pandemic-related shutdowns and lockdowns. Many of you will remember oil future prices dropping to negative during that year. Apart from 2020, the fund paid pretty solid dividends in most years.

In the long run, the fund's total return level is pretty much in line with its dividend yield. In the last 20 years, the fund returned an average annual growth of 7%. Considering its average dividend yield was around 5-6%, most of the fund's growth came from dividends. In other words, you could consider this as a pure income play.

The fund's total returns may lag total returns of American stocks, but you must understand that American stocks' total returns were mostly driven by tech stocks. If we compare EWA's total returns to that of American mining and financial stocks, you can see that EWA is not doing that bad, actually.

In conclusion, this ETF should have a small place in your portfolio if you would like to add a commodity-based income play to your portfolio. There are risks such as the effects of a global economic slowdown on commodity markets, geopolitical tensions between China and Australia, and risks involving real estate markets in Australia, but most of those issues would be temporary in nature and could only create more buying opportunities in the future.

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