Dividend Power: January 2015

Thursday, 29 January 2015

Severn Trent - Len Goodman's favourite stock?

Severn Trent: Probably Len Goodman’s favourite stock. (Think about it.) Well he might feel a bit lonely in the fan club right now. I felt looking at United Utilities yesterday that it lacked much attraction, but I think Severn Trent’s glitterball is looking a bit dated. As has United Utilities, they have accepted the regulator’s final determination for AMP6, although they will have had better outcomes in past reviews. Their statement has lots about investment and how good it all is for customers before getting to the meat of it for that other stakeholder; the shareholder. First a little bonbon in the form of a £100m share buyback in order to edge the net debt to regulatory capital value towards the regulator’s envisaged 62.5%. Then we get to the dividend policy. The dividend for the year to 31^st March 2016 will be cut by 5% from 84.9p to 80.66p. This might not be as severe a cut as analysts feared, with 10% being the whisper, but hardly a cause to break open some fizzy water. From there, the dividend will grow at RPI, as against the previous policy of RPI +3%. So if RPI is around 2%, the dividend will exceed the 2014/15 mark in 2018/19 just as AMP7 looms into view.

Trading at a premium to RCV and with an historic PE nestling above 20x, a curtailed yield of 3.7% (80.66p at 2175p) doesn’t look exciting. Maybe it has attractions to someone earning naff all on cash (or paying someone to look after the larger blobs of dosh) who wants safe cashflows and five years of relative visibility. For myself, I think income growth investors can do better elsewhere. (Neil Cumming^,29^th January 2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk Twitter: @DividendPower

Wednesday, 28 January 2015

United Utilities - Unexciting Upside

United Utilities: Utilities are always in a game of financial chess with the regulator, which for water companies peaks every five years. We are just at the juncture of the AMP5 and AMP6 regulatory periods. It feels like, for once, the regulator has edged the game without achieving checkmate. Anyway, the group has now accepted the regulator’s final determination for AMP6. This means that they have greater visibility for the five years through to 31^st March 2020, on the back of which the company has laid out its revised dividend policy. From the starting point of an expected 37.7p for the year to 31^st March 2015, they plan at least RPI growth each year. The main caveat is that they want to maintain their existing credit ratings, allied to which they will maintain a 55%-65% gearing ratio range (net debt to regulatory asset value). This policy is less generous than the RPI+2% for 2010-15, reflecting the lower returns allowed under AMP6 as against AMP5.

This looks pretty close to being an inflation-linked equity, which holds great attractions for income investors. However, the shares have been very strong and after a near 40% rise in the last year they have reached 1015p. Consensus eps for March 2015 are 47p, so the PE is a heady 21.6x, whilst the dividend of 37.7p is a yield of 3.7%. The Regulatory Capital Value is around £10bn, with equity at £6.9bn and debt of around £5.7bn. So the Enterprise Value to RCV is 1.26x, which feels full. The wild card as ever is corporate action, which could ‘move the goalposts’. With renewed regulatory certainty to 2020 the chances of an approach are in theory higher, but that chance shouldn’t be the only plank of the investment case. So, whilst current holders may be happy to stay put, these are not the right levels for fresh investment.

Next time: Severn Trent’s dividend cut.... (Neil Cumming^,28^th January 2015)

Tuesday, 27 January 2015

Crest Nicholson - Dividends Galore!

Crest Nicholson: The big news for income investors in these final results to 31^st October 2014 is the move to a higher dividend payout ratio. By 2017, they plan to reduce dividend cover to 2x, reflecting anticipated strong cash generation and a net cash balance sheet. In these results the dividend has been raised from 6.5p to 14.3p, up 120%. Forecasts for October 2017 are rather vague for now, but 55p for October 2016 is plausible, so 64p could be a reasonable target. Two times cover is a dividend of 32p, which at the recent 385p share price is a distant yield of 8.3%.

This must be predicated on good trading continuing, but with demand outstripping new build and modest price inflation outside the south-east, the medium term industry outlook seems solid. The slow moving planning process and capacity constraints mean that a glut of supply seems unlikely, whilst, with the economy on the mend, demand seems well based. Current national new-build is around 120,000, so Crest is but a small part at around 2,500. This low share leaves plenty of room to grow. The UK house building sector is prone to the boom bust cycle, but the next bust seems far away.

Shorter term, conservative eps for October 2015 of 45p is a PE of 8.6x. Assuming a step down cover of 2.5x, this is a dividend of 18p for a yield of 4.7%. My concern would be that NAV is 200p (historic), so price to book is up at 1.9x (but falling). Instinctively I am worried about a boom bust industry that politicians meddle with. That said there seems little reason for income investors not to consider Crest favourably after these results. (Neil Cumming^,27^th January 2015)

Monday, 26 January 2015

SSE - Power to the People

SSE: For income investors this seems nice and simple. The nine-month update re-iterates the expectation of a 2014/15 dividend increase of at least RPI inflation, with the same being targeted for 2015/16 and thereafter. At the interims to 30^th September 2014 the dividend was increased by 2.3%, which was the prevailing RPI rate. However the rate in December was 1.6%. With fuel and energy costs still coming down, alongside a supermarket price war, RPI looks set to stay low. A 1.6% rise for the year would see last year’s 86.7p dividend rise to 88.1p. So doing the maths: knocking off the interim of 26.6p gives a final of 61.5p, which is only a skinny 1.3% increase over last year’s final of 60.7p. This may all seem rather hair-splitting though when, at 1517p, an 88.1p dividend is a yield of 5.8%.

However, there are other reasons to be wary. It was a mild Autumn and in the first nine months, domestic customers (whose numbers dropped 4.3% to 8.7m) used less gas (-15.8%) and electricity (-5.6%) per household. Prices to customers are coming down (gas by 4.1% in April), with politicians baying for more. Labour’s price freeze proposal is turning into a price cap rhetoric. It is problematic whether price cuts now would be hauled back if Labour gain power in May. Further, with forward purchase contracts locked in at higher prices and wholesale gas prices dancing to a different tune from oil, margins must look under pressure. SSE are more succinct, calling it a ‘challenging business environment’. Further, as one major regulatory chapter closes with the acceptance of distribution price controls for the next eight years, so a smaller one starts with an inquiry opens over the connections market.

In addition the pile of debt and quasi-debt grows. Company guidance is that it will be around £7.8bn by 31^st March 2015, up £200m yoy. SSE may be a safe asset backed business but that is still some 3.4x net debt to EBITDA. The company is also flagging that eps progression in 2015/16 and 2016/17 is subject to additional risk, when last year’s 86.7p dividend was only covered 1.4x. It is a thin line between a nice high safe dividend being churned out on a high payout ratio and a balance sheet struggling to cope with the demands on it. I am worried that SSE might be straying too close to that line. (Neil Cumming^,26^th January 2015)

Thursday, 22 January 2015

Royal Mail - your dividends will be in the post

Royal Mail: Despite being almost 500 years old the company is still a stock market ‘newbie’ finding its feet after all the controversy of the badly executed float. When we last heard from them they were bemoaning new competition in parcel deliveries from Amazon, which is also one of their cornerstone customers. Since then, in a cut throat market, City Link has gone bust, taking a modest amount of capacity out. These nine month numbers include the busy Christmas period as they go to 28^th December. In December alone they delivered around 120m parcels, up 4% on last year. Over the nine months, parcel volumes are up 3%, showing an acceleration over the first half figure of 2%, although revenues are flat as price competition bites. Letter volumes continue to decline, but at -3% this was better than the predicted 4%-6% long term trend. In GLS (the overseas operations) volumes and revenues were both up 8%, although a warning bell is sounded about increased costs due to the implementation of an Euro8.50 per hour minimum wage in Germany. The unwinding of their property endowment saw them receive £111m from the Paddington site sale. Their controversial plans for (over) development at Mount Pleasant also are progressing.

Overall, the group says that it is trading in line with expectations and that there are no changes to guidance. The market has been cheered by signs that RMG is fighting its corner in the parcels market and that group wide cost efficiency measures are holding down operating costs. Having popped up to 443p, consensus eps for March 2015 of 32p is a PE of 13.8x, dropping for March 2016 to 13.2x on 33.5p. On these eps, the dividend is likely to be 21.3p rising to 22.3p the year after for a yield progression from 4.8% to 5%. These look fairly attractive metrics, but given the trading history of the shares there may well be more chances to look at the stock nearer the £4 mark over the coming months. (Neil Cumming^,22^nd January 2015)

Wednesday, 21 January 2015

Pearson - educating and informing the world

Pearson: The long term structural change programme at Pearson has left Education (including running exam systems) front and centre of its operations. This leaves the group well placed to benefit in a world where population growth continues unabated. Whilst established markets, especially North America, are the current focus, in the long term more and more aspiring nations will focus on advanced education in order to gain a competitive edge. There is also the in-built advantage that more and more emerging nations’ educational systems choose (or accept) English as their language of education. Alongside education, the group owns the Financial Times and has a 50% stake in The Economist Group. In 2012, Penguin was placed into a vehicle alongside Bertelsmann’s Random House. This venture, of which Pearson own 47%, is stated to be the largest consumer book publisher in the world.

The group normally offers explicit guidance to analysts and the post-close trading update for the year ending 31^st December 2014 is no different. Previous guidance of 62p-67p of eps has been tightened to a top end 66p, helped by a lower than expected tax charge and a currency tailwind. For 2015 the eps guidance has been introduced as 75p-80p, assuming exchange rates and trading conditions are stable. In the five years 2009-13, eps have ranged between a high of 86p (2011) and a low of 65.4p (2009). Having restructured the publishing activities (and executed the Random House deal) along with riding various road bumps in the US educational budget, the challenge now is to deliver eps growth. After a 55p share price rise on this update to 1295p, the shares are on a PE of 19.6x, dropping to 16.7x (at the 2015 guidance mid-point). Throughout this period, long term confidence has been displayed through a progressive dividend, with growth around 6%-7% p.a. That implies a 51p dividend for 2014 and 54p for 2015, producing a 3.9% yield rising to 4.2%.

None of this seems very eye-catching, but looks more attractive when you consider the good long term prospects for global education demand and the brand names such as FT that they own or have an interest in. This could be a good long term tuck away, once some of today’s froth subsides. (Neil Cumming^,21^st January 2015)

Tuesday, 20 January 2015

IG Group - Swiss miss

IG Group: These interims were over-shadowed by last week’s Swiss Franc bloodbath. The initial estimate is that this could be a £30m hit to IG, being £12m of customer goodwill (i.e. cutting them some slack) and £18m of bad debt, although that already appears to be an over-estimate. The silver-lining to this Swiss cloud is that it is as unusual as a Spurs league title. The Swiss National Bank was only forced into this by the imminent start of the EU’s version of QE, a rarity on the scale of the UK’s ERM exit. Investors having seen the collapse of other providers will be reassured by IG’s calm ‘sh*t happens’ response and they may well pick up new accounts from wounded or bust rivals. This would add to some good market positions as IG is already 32% of the UK’s CFD market and 41% of UK financial spread betting, as well as offering forex trading. They are gently expanding their geographic footprint and have, in the UK, started execution only broking. This could become a decent profit stream, but it also acts as a source of warm leads for the CFD/spread betting activities. So the core business looks well placed for growth for some years to come.

Obviously, the year to May 2015 will see eps come down from last year’s 40.2p, due to the Swiss Franc event, to maybe 37p, before picking up to 46p by May 2016. At 745p that is a PE of 20.1x, dropping to 16.2x. The interim dividend is 8.45p and is 30% of the total, making that 28.2p for a yield of 3.8%. This is flat on last year, with the company saying that it will be paid despite the Swiss affair unless anything else happens to make payment imprudent. The normal 70% payout ratio means that for May 2016, 46p would be a dividend of 32.2p for a 4.3% yield. This is a stock that many will shy away from given the transactional nature of revenue generation, but they have now clocked up 40 years. That gives them kudos in an industry prone to fleeting success stories and makes them worthy of consideration. (Neil Cumming^,20^th January 2015)

Monday, 19 January 2015

Greene King - slight seasonal blip

Greene King: This seasonal trading update could be seen as a bit mixed, with something for both bulls and bears. Retail LFLs were up 2.0% over the festive period, meaning that year to date the measure is +0.6%. However, since then LFLs are only flat in somewhat soft trading, although they do point out that they were up against some tough comparatives from this time last year. They also note an impact in Scotland from new, tougher, drink driving laws. Whereas the breath test in the rest of the UK stays at 35mg, in Scotland it is now 22mg, in line with most European countries. So it probably just as well that they are custodians of Belhaven 80 Shilling, rather than Tennent’s Super. Greene King also mentioned a soft run up to the festive season, citing their survey that in November household leisure spending was down 8% year-on-year. However, that survey pre-dates the bulk of the stimulus as oil price falls fed through to forecourt petrol prices. The Spirit Pub deal has been approved by both sets of shareholders, so it is now eyes down for any horse-trading required by the competition authorities, with completion hoped for in the first half of 2015.

For the year to end-April 2015 eps of 61p would be a flat year before growth of c10% in each of the next two years (plus Spirit on top). That 61p supports a twice-covered dividend of 30p, to give a PE of 12.9x and a yield of 3.8% at 789p. Despite having edged up from 755p, when I wrote on the stock in early December, these metrics still offer good value and the stock appears a good tuck away. At current prices I reckon there is a couple of pence also to squeezed out by buying via Spirit instead, if you are happy that the deal will go ahead and not be blocked. (Neil Cumming^,19^th January 2015)

Friday, 16 January 2015

Home Retail - a Woolworths for our time?

Home Retail: They seem to be a good example of what is silly about the latest US import: Black Friday. All it does is to suck in sales around that day, at the expense of margin and the risk of poor fulfilment. In the case of Argos (about three quarters of group turnover), Black Friday sales were up 45%, with a threefold increase in digital hits to 13.5m. After the distortion of Black Friday, they then decided to protect margins, at the expense of sales, through the Christmas season. This meant that LFLs over the 18 weeks to 3^rd January were +0.1% against expectations nearer 2%. However, margins fared better, being flat YTD (44 weeks) but up 25bps over the 18 weeks. At Homebase (the other quarter of sales) the managed decline continues, with more stores having closed and more to be closed. The resultant clearout of stock explains a 100bps margin drop over 18 weeks, with LFL sales up 0.6%. On the face of it this is worse than the 44 week data showing LFLs up 2.9%, with a lower 75bps margin drop. Overall the group states that pre-tax profits are still in line with consensus expectations.

For the year to 28^th February 2015, these expectations are for 11.7p of eps, making a PE of 17.1x after the markets’ reaction took the shares down to 200p. On a 3.54p dividend that is a yield of 1.8%. A year out some growth to eps of 12.7p and a dividend of 3.93p is forecast for a PE of 15.8x and a yield of 2.0%. These are not startlingly cheap for a group still trying to find its new role in a bricks and clicks world. I noticed before Christmas that Argos is using pop up click and collect sites, but that seems rather like a pea-shooter against the raw power of Amazon. As for Homebase, it might be summed up well by the Tunbridge Wells store, which sits forlornly, all peace and quiet, providing extra parking spaces for the Sainsbury with which it co-habits. Home Retail’s struggle to find a place in a new retail world seems all too reminiscent of Woolworths in the 1990’s. Overall this stock still doesn’t do it for me. (Neil Cumming^,16^th January 2015)

Thursday, 15 January 2015

Saga - when is a retailer not a retailer?

Saga: After coming to market with the class of 2014, Saga is one of those yet to sign up a fan club. Perhaps this is in part because, despite looking like a financial services group, they managed to get themselves classified into the General Retail sector. From a rating point of view that looked clever, except that now no one quite knows quite how to look at them. As the CEO, Lance Batchelor says, “I am very clear that our model is predominantly that of a broker, accessing the best products for our customers and delivering them with our own high standards of customer service”. This chimes with their maiden interims last year when, of £130.4m of EBITDA, Financial services were £114.5m. Travel was £15.2m, Healthcare £1.9m less central costs of £1.2m. In the summary of today’s Capital Markets’ Day the importance of Financial Services is being dialled up further through a wealth management jv with Tilney Bestinvest, whilst Healthcare is dialled down by looking to ditch the NHS and Local Authority care homes business.

Overall the opportunity for Saga is huge. There are over 20m over 50s in the UK and that is growing fast. At the interims they said that, at 10.6m names, they have just over half on their database, but only 2.7m are active customers. So they have plenty of scope to deepen and widen their pool of business. Current trading for the year just finishing, to 31^st January 2015, is described as in line. This would be consensus eps of 10.5p, meaning a PE of 15.5x at 163p. They state that the dividend should be at the top end of the 40-50% payout range. So 50% would be 5.25p, but there is only a final this year so I will guess at a 1/3: 2/3 split for a dividend of 3.5p and a yield of 2.1%. Looking out a year, the eps consensus is 13.7p, a PE of 11.9x and a 50% payout would be 6.85p, for a decent yield of 4.2%. This all seems quite attractive, but perhaps the next move is to get themselves put in the right sector, so that the right sector specialists can get to grips with them. (Neil Cumming^,15^th January 2015)