Dividend Power

Monday, 23 March 2015

Pennon - in OFWAT's good books

Pennon: After the dividend disappointments at Severn Trent and United Utilities, it is a pleasant relief to see Pennon extending their existing dividend policy of RPI+4% into the full 2015-20 K6 period. They are upbeat on the prospects for South West Water to exceed their assumed return on equity over this period, having beaten the targets for K% (2005-10). They even seem to have managed to claw back in K6 the lost revenue from the 2014/15 price freeze. These all seem to be benefits from having got into OFWAT’s good books for good behaviour. Over at the Viridor waste business, the recession post the banking crisis was a very tough period for a business focussed on landfill. The parallel trend for less landfill (encouraged by higher landfill taxes) and more recycling also hurt. The company is saying now that the strategic re-positioning of Viridor into an ERF (Energy, Recycling & Resources) business is at an inflection point and that EBITDA is set to move ahead this year. This is despite poor recycled material prices caused by low commodity prices. The pipeline of new contracts and business mean that further progress is envisaged too, with ERF forecast to contribute £100m to EBITDA by 2016/17.

This is all positive news, but the rub is that the valuation looks fairly rich to me. Consensus eps for the year to 31^st March 2015 looks like 37.5p, being a chunky PE of 22.5x at 845p, with high single digit growth thereafter. The dividend could just break 32p, which is a yield of 3.8%, (with that RPI+4% growth trajectory beyond). This all looks enough for now. The wild card is corporate activity. The group has been eyed up in the past, most notably in the recent past by the Abu Dhabi Investment Authority. Only this month Jonson Cox (the OFWAT Chairman) signalled that he was now more open to the idea of corporate activity of various kinds in the sector. The last official Asset Value of Pennon was £5.0bn against a current Enterprise Value of some £6.2bn, whilst the Regulatory Capital Value of South West Water is probably just over £3bn and not far short of the £3.4bn market capitalisation of Pennon as a whole (an apples and pears comparison but interesting all the same). It is all a bit ‘finger in the air’ but a corporate buyer probably could still justify paying a decent premium to the current share price. Whether it is worth hanging on for that I am not sure, the choice is yours. (Neil Cumming^,23^rd March 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

Thursday, 19 March 2015

Budget 2015 - The joy of Equity Income investing

Budget 2015: I am not a qualified IFA, so none of the following can be taken as advice. I would also remind you that I may have got some fine detail wrong, so make sure you get proper advice if that is what you need. Overall though, what a great fiscal framework we have for an equity income investor. As Chancellor, George Osborne has made some radical fiscal changes to the environment for the personal saver. In normal times these would help anyone investing in a wide variety of income producing assets, but we do not live in normal times. An effect of Quantitative Easing and its like, is that high grade bond yields are derisory. Low bond yields have made the individual annuity an unattractive product and led to the recent, unprecedented, relaxation in personal pension fund rules. Property and equities seem to be the only major asset classes left that offer a realistic prospect of real returns at an acceptable level of risk.

As an equity investor there are two mainstream, tax efficient, ways to save, being pensions and ISAs. There are also equity vehicles such as EIS and VCT, but they do carry extra risks for the rewards and will not be suitable for many. Whilst annual pension contribution limits and reliefs have been repeatedly trimmed, for most people they will not find this a practical problem. The annual lifetime limit has also been cut, with the new level to be £1m, but most people can only dream of being affected such a problem. Start young enough though and you may just be surprised. Then, thanks to George, your pension pot can be accessed in a variety of ways, without using old style annuities, and you have the possibility of leaving your pension pot in your will, without a penal tax rate being applied. Likewise ISAs have been made more flexible, with the main distinctions between cash and stock ISAs abolished. The annual contribution limit having been raised to £15,240 for the coming tax year means that a visible pot can be accumulated quite quickly. In future it seems that you will also be able to dip in and out of the cash element within each tax year, adding greater flexibility to what used to be a near one-way valve. When you die, the ISA wrapper can be passed on, so avoiding moving the pot into the taxable space. The final carrot is that, in the taxable space, the first £1,000 of investment income on cash will be tax-free for basic rate taxpayers. Even if you pay tax at 40% you will still get a £500 allowance.

For most people, structuring your savings in a tax efficient manner has become an awful lot easier to do. Within that, the tried and trusted studies on the effects of re-investing dividends, from equity investments, have become more powerful thanks to the ability through various vehicles to take more investment income tax free. So the fiscal framework is very supportive. The difficult bit, as ever, is choosing the right equities or collective schemes to invest in. (Neil Cumming^,19^th March 2015)

Wednesday, 18 March 2015

Cape - Joe 90 and the Caped Crusader

Cape: CEO Joe Oatley rescued Cape from a near death experience when he arrived in 2012. He now finds himself running a services group focussed on the energy and mineral sectors, just when the industry is in a vicious bear phase. So it is to his credit that these annual results to 31^st December 2014 show such solid progress. Continuing revenue is up 3.5% to almost £700m, whilst order intake is up 22% to leave the order book 15% up at £746m. Adjusted pre-tax profits were £45.3m, sharply up on £35.1m, to leave eps at 29.9p, up 28.3%. The annual dividend was held at 14p and is now twice covered. Adjusted net debt was up from £60.2m to £101.0m, due to acquisitions, and higher working capital as revenues built, with cash conversion dropping from 151% to 65%. Net debt at this level is 2x EBITA, which is not overly demanding in a recovery phase. In such a bear market it is reassuring to see that the more resilient maintenance revenue stream is now 70% of total revenues, helped by the £36.6m Motherwell Bridge acquisition last year. A further help is the lack of exposure to North American shale, whilst key areas such as Saudi Arabia are still active.

Looking forward, the group acknowledges the uncertainties in the oil and gas construction market in particular. So they are shooting for a similar 2015 outcome to 2014, but with the second half being more uncertain than the first half. So if they reach 29p (a small reduction on 2014’s 29.9p) then, at today’s perky 235p share price, that is a PE of 8.1x and a same again 14p dividend is a 6% yield. This seems undemanding and only a little more improvement in sentiment would be needed for a 10x PE to be justified for a 290p share price (when the yield would still be 4.8%). This is clearly not a stock without risks, but the rewards are there for the more adventurous income hunter. (Neil Cumming^,18^th March 2015)

Smiths Group - Holding out for a hero...

Smiths Group: When Philip Bowman joined as CEO, in December 2007, most investors saw his prime remit as the sale of the group, either as a whole or in bits. This was a fair assumption as Smiths was an uneasy mix of activities and Bowman’s previous two jobs had been the sale of Allied Domecq and Scottish Power. Now, as he heads for retirement at the end of the year, the group is also looking for a new CFO as Peter Turner departs for ‘other opportunities’. Whilst the 2007/8 banking crisis greatly reduced the appetite and firepower of financial and corporate buyers, the great failure is that the group is substantially the same beast as when Bowman arrived. So now it is a case of who next and what next.

In these interims to 31^st January 2015, reported revenue is down 2% and operating profit down 5% on a 60bps margin squeeze, with a currency headwind partly to blame. This drops through to eps of 38.5p, down 3% and a dividend of 13p (up 2%). Operating cash flow conversion was 88%, but debt crept up from £804m to £929m due to higher dividends, pension costs and forex. The pension hole grew from £236m to £338m, as falling yields hurt. Across the five divisions, Medical made operating profit progress, as did Flex-Tek, whilst John Crane marked time and Detection and Interconnect fell back. Getting all five cylinders to fire at once has been the elusive challenge for Bowman and remains so. The mixed outlook for the second half sees Medical likely to slow, Interconnect to be below last year’s second half, John Crane to see the effect of the oil price collapse, Flex-Tek to grow and Detection to pick up against soft comparatives.

The strategy talks about targeting revenue growth, “as we seek to re-position” the group. I’m not quite clear how, ahead of major boardroom changes, this will be a year of significant achievement or change. It feels like a case of wait and see for news of new appointments, which will no doubt presage a strategic review a few more months down the line. For now the shares are 1160p, which on eps of (at a stretch) 80p is a PE of 14.5x. Long-term dividend cover is targeted to be around 2.5x, but is nearer 2x at present. So a 40p dividend would be an acceptable yield of 3.5%. So, as is often the case with Smiths, the shares look OK value, but the real spice will only come with a new boardroom team that excites the company and the shareholders. (Neil Cumming^,18^th March 2015)

Monday, 16 March 2015

Morrison (Wm.) Supermarkets - we are all Tesco now

Morrison (Wm.) Supermarkets: As the board might say “we are all Tesco now” as new CEO David Potts settles down next to fellow Cheshunt alumni Andrew Higginson (Chmn.) and Trevor Strain (FD). These annual results to 1^st February 2015 were grim with the dividend outlook trashed, but we all expected that. It is now all about the future and whether Morrison can rediscover its mojo. (Not that mojo is on many of their customers’ shopping lists.) It is tough to be a supermarket when your LFL sales are down 5.9% (on top of the -2.8% in 2013/14) and operating margins were down 189bps year-on-year. This sent operating profits down to £442m, but then come impairment and property disposals to take the group to a £696m loss. Property impairments of £1,273m show how much demand for such assets has been eroded. (So well worth checking your property company shares for risk in this respect.) Underlying eps were 10.9p (-53%) on the back of which they have bumped the (now uncovered) total dividend up 5% to 13.65p, in line with previous guidance.

Now starts the hard slog of investing in more price cuts and achieving cost savings. The former total £315m so far, offset by £224m of cost savings with an eventual savings target of £1bn. Many of previous CEO Dalton Philips diversions (Kiddicare etc.) have already gone, but now comes their acceptance that the late entry into conveniences stores has not been a success. New ‘M’ store openings will be severely curtailed and the worst of the shops will be closed. Another cost saving is the dividend, which will be “not less than 5p per share” this financial year. All this will probably avoid the need for fresh equity, but that is not a certainty. The group is claiming some early success in turning the trading tide, but generally conditions are still ferocious, with a general background of deflationary pressures helping no one much. Morrisons needs to bin the de-misters and get back to being the great value first port of call for its heartland customers. Whether that will be enough, is unknowable at this stage. So far, the shares have rallied since the lows of the autumn, to around 203p. Assuming flat eps at 10.9p for FY2015/16 is perhaps harsh, but prudent. Along with a 5p dividend that is a PE of 18.6x and a yield of 2.5%. That may be tempting if you believe in a recovery, but I can’t see the rush, especially if income growth is your bag. (Neil Cumming^,16^th March 2015)