Dunedin Income & Growth says it recorded its first year of negative absolute returns since the banking crisis of 2008/09 with a NAV Total Return of -11.5%. This meant it underperformed the FTSE All-Share Index by 6.9%. The Board is proposing a final dividend of 3.675p per share which will make a total dividend of 11.4p per share for the year, an increase of 1.3% on last year and in line with the rate of inflation as measured by the Retail Price Index. The discount widened from 2.5% to 4.6% as at 31 January 2016 (on an ex-income basis with borrowings stated at fair value).
The FTSE All-Share Index fell by 4.6% on a total return basis. This performance was supported by strong returns from both consumer-facing companies and mid and small capitalisation stocks, aided by their greater exposure to domestic economic trends. To add some context, the FTSE 250 Index increased by 3.8% on a total return basis and the FTSE SmallCap (ex Investment Companies) Index increased by 5.8%, while Beverages and Tobacco were the two leading sectors in terms of their relative contributions to the FTSE All-Share’s performance.
The manager’s report mentions a number of stocks that impacted on the fund’s performance.
Inmarsat, a satellite telecommunications company, has had a successful year having launched the latest generation ‘Global Express’ satellites which gives them the platform to deliver a steady and growing new revenue stream from 2016 onwards. In addition they have taken promising steps towards delivering broadband connectivity for passenger aircraft which has the potential to be a significant opportunity for them in the long term. They remain confident in the outlook as demand for high speed mobile data communications continues to grow, and Inmarsat are in a unique position to capitalise on this with their dominant market position and very high barriers to entry.
Sage, which provides accounting software to small businesses, is benefiting from the actions of a relatively new management team who are refocussing the company on the fastest growing parts of their portfolio. The early signs are that the execution of their strategy is going well, whilst at the same time the original attractions of the Sage business model remain, with their unrivalled market position, high degree of recurring earnings and strong cash flow generation.
Specialist personal lender Provident Financial had an excellent year, achieving high growth in earnings which allowed them to increase the dividend by 27%. They continue to benefit from rising demand in an underserved market, with a model which is very difficult for competitors to replicate allowing them to maintain a strong market position. Due to a combination of their product initiatives and favourable market backdrop we believe that they are well poised to grow over the long term.
Unilever has been facing tougher market conditions as it generates the majority of its revenue from the slowing emerging markets. Nonetheless they have managed to grow ahead of the market and deliver strong results in 2015 with a double digit increase in underlying operating profit. This has been driven by production innovation and sharpened category strategies that have helped support their brands and infrastructure. They believe they have a sensible strategy which should allow the company to continue to grow its top line at a reasonable rate, whilst continuing to make incremental improvements to margins. This will put them in good stead for further growth in earnings and dividends in the upcoming years.
The managers thought it would also be helpful to also address five companies which particularly hurt relative performance and tackle each one in turn to explain why they expect returns from those investments to improve.
Pearson is the world’s leading for-profit education business with high market shares and extremely valuable intellectual property and technology. It is currently facing cyclical and policy related headwinds in a number of its key markets which has led to a recent substantial decline in the share price and a significant de-rating of the shares. We believe that these problems will prove to be transitory as effects annualise and enrolments in US higher education colleges stabilise. In addition they believe that a return to growth, combined with the recently announced cost cutting plans and the support that they have from their strong balance sheet, should see a significant recovery in the market value of the company.
Centrica is a vertically integrated utility company that has faced tough trading conditions, in particular in its upstream business due to falling oil and gas prices. This has put pressure on earnings and in turn led them to rebase the dividend. However, whilst material commodity headwinds persist, the company is delivering resilient results under the strategy of the relatively new management which involves more focused capital expenditure and significant cost reductions. Cash flow is expected to increase in future years which will support dividend growth whilst at the same time maintaining a robust balance sheet and allowing them to invest in sensible growth opportunities. Regulatory and political uncertainty around Centrica’s retail energy supply business has not helped sentiment towards the company; however it is looking increasingly likely that any regulatory intervention will not have a significant impact on financial performance.
BHP Billiton has long been regarded as the leading diversified miner given their breadth of high quality assets and low cost of production. However, alongside others in the sector they have faced significant headwinds from very weak commodity prices and as a result they have seen a sharp decline in profits and cut the dividend. It is likely that conditions will remain tough in the near term, however management are taking the appropriate actions to ensure that they emerge from this cyclical downturn in a strong position. Examples here include significant reductions in costs and capital expenditure and a change to a more flexible dividend policy which will allow them to continue to generate positive cash flow in this low price environment. The balance sheet remains one of the most robust in the sector and their ability to survive a prolonged downturn is not in question. They look well set to emerge in a stronger position once the cycle starts to turn in their favour. They are of the view that the valuation is already pricing in a bleak outlook and therefore for the patient long-term investor there is significant upside for those willing to wait through the down-cycle.
Standard Chartered has a strong retail and commercial banking network in economies that enjoy high long-term structural growth such as Africa, the Middle East and Asia. It has, however, been hit by the recent cyclical slowdown in emerging market economies and over-exposure in lending to commodity producers. Under the new management of Bill Winters, the bank is taking action to raise capital, improve credit quality, cut costs and realign their operations to where they have the most significant competitive advantages. Conditions are likely to remain tough over the next 12-18 months but the current valuation is even lower than that experienced by the bank in the depths of the 1997/98 Asian crisis and the potential rewards for investors who are prepared to stick with them through this challenging period are substantial.
Weir Group sells equipment such as pumps and valves to the oil, gas and mining sectors and therefore has been another company that has suffered on the back of lower commodity prices. What differentiates Weir from its competitors is the fact that they have a strong aftermarket servicing business that helps buoy profitability and cash flow during times of lower equipment revenues such as now. In addition, the management have been through cycles in the past and are well experienced in reducing costs. Their good cash generation is allowing them to continue to invest in medium-term growth opportunities in a measured way, meaning that they are well set to not just survive the current downturn, but to emerge in a stronger competitive position.
DIG : Poor year of returns for Dunedin Income Growth