Dunedin Income Growth’s results for the year ened 31 January 2023 show that its NAV increased by 2.4% on a total return basis, underperforming the All-Share Index which produced a total return of 5.2%. The chairman notes that just 23% of companies outperformed the benchmark index. The best performing sectors were energy, defence and mining which are typically sectors in which the company is, and has been, underweight.
The share price total return for the year of -0.9% underperformed the NAV total return, reflecting a move from a small premium of 0.3% at the end of last year to a discount of 2.9%.
The revenue return per share increased by 1.2% to13.0p. The company’s total dividend of 13.1p per share for the year, is 1.6% higher than last year, but was not quite covered by earnings. [We think that the board is keen to maintain the trust’s record of dividend increases] This will be the 39th year out of the past 43 that the company has grown its dividend, with the distribution maintained in the other four years. Having increased the dividend in every year since 2011, the trust is an AIC “next generation dividend hero”.
More overseas
The board and investment feel that the part of the investment policy relating to the limit on the exposure to investments in companies listed or quoted overseas should be amended from its current limit of 20% to a new limit of 25%. They argue that this higher limit will provide the investment manager with greater flexibility to invest in overseas companies but does not represent a change in the way that the portfolio is managed and it is not a material change to the investment policy that would require shareholder approval. The change will take effect on 1 May 2023.
Extract from the manager’s report
We are pleased with the portfolio’s income progression in the year. Having started the year expecting net revenue of around 12p per share, the net income generation of 13.0p per share exceeded our expectation. This is despite missing the very substantial contribution from Rio Tinto’s special dividends and the expected dividend cut at GlaxoSmithKline given corporate changes. A number of holdings in the portfolio delivered strong dividend growth, including Morgan Sindall, ASML, London Stock Exchange, Pets at Home, Novo-Nordisk and TotalEnergies. We continued writing options based on our fundamental analysis of holdings in the portfolio and this has been a benefit to the Company by diversifying and increasing the level of income generated.
The year under review saw markets digest a number of extraordinary exogenous shocks. From the tragic war in Ukraine leading to soaring power prices, the highest level of inflation since the 1980’s, aggressive central banks tightening, UK Government leadership change and swings in consumer confidence. These factors have caused sharp rotations and shifts in market sentiment towards many companies that performed well in the preceding decade. Against this difficult backdrop, the Company delivered a flat absolute return in the first six months to July but lagged in the second half when the UK political environment deteriorated.
There are a number of themes driving markets. The portfolio’s underperformance relative to the benchmark was primarily driven by market style rotation and factor risk, offset by positive stock selection. The Company’s sustainable and responsible investing approach includes negative exclusions, alongside the positive allocation to sustainable leaders and improvers and corporate engagement. Risk analysis concludes that, this year, the Company’s negative exclusions, which restrict the investable universe by approximately 22%, caused a headwind to performance but that the portfolio outperformed its investable universe.
Reassuringly, fundamental analysis and stock selection contributed positively in the year. The UK market has been a hunting ground for international buyers looking to take advantage of discounted valuations and the underappreciated quality of many companies. Global investors are looking on the UK market more favourably than in recent years and we see M&A as a feature of the market which we expect to continue going forward. A number of holdings in the portfolio were bid for in the year as global investors capitalised on the opportunity to acquire companies with strong business models and market leadership at attractive valuations, further boosted by Sterling weakness. The Company’s long-standing holding in the industrial software company Aveva came to an end when it was bought by majority shareholder Schneider Electric, valuing the company at £9.9 billion. In addition, the events and database business Euromoney Institutional Investor received a take-over offer from the private equity sector.
The portfolio benefited from its overseas exposure. TotalEnergies’ portfolio of assets delivered strong profit progression and cash return including a 6% dividend yield in addition to share buybacks. While near term weakness in natural gas prices will hold back earnings momentum, we see the company as well positioned to benefit from structural under-investment in upstream energy markets and judge its energy transition strategy as credible. Danish pharmaceutical company Novo-Nordisk raised guidance through the year, driven by growth in diabetes therapies and the positive launch of anti-obesity treatment Wegovy. The prepaid vouchers and employee benefits solutions company Edenred out-performed expectations with growth in its SME business, supporting margins. It remains at an attractive valuation for the growth we expect the company to deliver.
After building a position in Games Workshop in the year, the company issued a surprise announcement that it had reached an agreement with Amazon to develop Games Workshop’s intellectual property into exciting film and TV content. Recent addition to the portfolio Taylor Wimpey contributed positively with its shares recovering from lows at the time of the mini budget as the market recognised its highly discounted valuation.
The FTSE All-Share Index return for the year was highly concentrated in a narrow set of companies, namely in the Energy and Basic Materials sectors. Supply constraints due to the war in Ukraine, coupled with post Covid recovery in activity led to strong oil price appreciation. As a consequence, BP and Shell delivered healthy profit growth, cash generation and shareholder returns over the period. The Metals and Mining sector also had a strong year, with the diversified miner Glencore returning over 50% on the back of strong commodity price inflation including in thermal coal. The Company’s investment policy leads us to be underweight these sectors due to our preference for investments with a higher degree of earnings visibility and stability and more dependable dividend distribution track records. Not owning large index constituents such as BP, Shell, Glencore, Rio Tinto and Anglo American proved a significant relative headwind over the year.
In addition to the quality focus of the portfolio, the sustainable and responsible investment approach draws attention to the long-term risk facing the Energy sector as global economies transition to low carbon fuels to mitigate climate change. The policy focuses our efforts on companies at the forefront of energy transition, with a material proportion of revenues from transition energies such as national gas, in addition to renewables. Here we see Total Energies as a leader in the sector. The decision to hold back investing in BP and Shell for environmental reasons has been corroborated this year, with both companies pulling back on plans to roll out low carbon energy capex. However, we recognised this was taken well by the market given the uncertainty of returns in alternative energy assets.
Political turmoil in UK politics in the second half of the year, triggered by the government’s ‘mini-budget’, led to a sharp rise in interest rate expectations, a fall in Sterling and a sell-off in companies heavily exposed to the UK. 2022 saw the UK domestic focused FTSE 250 Index lag the large cap FTSE 100 Index, with the quantum of underperformance greater than during the 2008/09 financial crisis. With 27% of the portfolio invested in UK mid and small caps, this allocation detracted from performance with companies such as the housebuilder Persimmon, online greetings cards company Moonpig, and leading high street pet retailer Pets at Home underperforming in the period. Whilst there are pockets of weakness, particularly in housing transactions and big ticket discretionary spend, recent trading has indicated the UK consumer is holding up. Meanwhile, valuations have been rebased and we believe the long run track record of alpha generation from UK mid-caps will return.
There are two stock specific detractors in the year to highlight. Direct Line Insurance issued a disappointing profits warning in January 2023 on the back of major weather losses, claims inflation, delays to motor rate rises and commercial property investment losses. Pressure on the company’s balance sheet has meant its dividend has been suspended as the company looks to rebuild its capital position. The building materials company Marshalls lowered forecasts in October following softening consumer demand in its landscaping business. The company embarked on a restructuring programme to manage its cost base and protect profitability and has subsequently issued a reassuring update to the market.
DIG : Dunedin Income Growth lags benchmark ekes out dividend hike