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HL Select UK Income Shares: May Review

HL SELECT UK INCOME SHARES

HL Select UK Income Shares: May Review

Monthly roundup

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Charlie Huggins

Charlie Huggins (CFA) - Fund Manager

6 June 2017

The UK stock market continued its upward trajectory in May, despite on-going political and economic uncertainty. The FTSE All Share rose by just over 4%, while the yield on 10 year UK government bonds fell further, ending the month at a smidgen over 1% (versus a 30 year average of around 5%). Investors in these bonds are effectively paying for something that offers a return well below inflation, and that has no prospect of growing, albeit with greater security and less volatility than shares can offer. In this context, it is easy to see why high quality businesses with the potential to grow profits and dividends, remain in demand. Remember all investments can fall in value as well as rise so you could get back less than you invest.

Below we highlight the biggest positive and negative contributors to fund performance in May. However this is over a very short period and past performance is not a guide to future returns.

Biggest positive contributors

Company Total return (%) Contribution to fund (%)
Unilever 9.87 0.47
Astrazeneca 12.86 0.44
GlaxoSmithKline 11.19 0.43
Reckitt Benckiser 11.63 0.42
National Grid 7.20 0.32

Unilever was our best-performing stock this month. The strategic review that it completed last month, promising higher margins, cash flows and dividends, has gone down well with investors, and analysts have been upgrading their earnings forecasts. With the prospect of strong earnings and dividend growth over the next few years, we remain very comfortable having it as our largest position in the fund.

Elsewhere in the consumer goods sector, Reckitt performed well, with investors approving its acquisition of Mead Johnson at the end of the month. We too chose to approve the deal, following a conference call with RB’s management. Inevitably, there are short term risks involved with integrating an acquisition like this, and Mead Johnson’s sales have been declining over the last couple of years. But we view the infant formula category as fundamentally attractive, and we back RB’s management to turn the business around.

Our pharmaceutical holdings were strong this month. AstraZeneca was buoyed by a string of positive clinical results from its drug pipeline, including a positive read out for Imfinzi, for the treatment of non-operable lung cancer. Peak sales for this drug are estimated to be over $2 billion.

GlaxoSmithKline also performed well after the launch of a competitor to its blockbuster asthma drug, Advair, was delayed. Sooner or later, generic Advair will arrive but this latest delay will support GSK’s earnings in the near term and give their newer respiratory drugs more time to build momentum.

National Grid issued full year results during the month. NG’s key underlying attraction remains its highly visible, regulated cash flows supporting investment to grow the asset base, and underpinning the group’s aims to grow the dividend at least in line with RPI inflation. It won’t be our fastest-growing holding by any means, but we expect it to be a reliable dividend payer.

Biggest negative contributors

Company Total return (%) Contribution to fund (%)
Paypoint -7.03 -0.24
Close Brothers -5.38 -0.22
Imperial Brands -3.36 -0.16
Domino’s Pizza -4.08 -0.13
Provident Financial -1.95 -0.09

Our worst performer this month was Paypoint on the back of a fairly uninspiring set of full year numbers. We think Paypoint will struggle to grow profits over the next few years. That said, the dividend policy means that total shareholder returns should still be reasonable, in our view. The group aims to grow the ordinary dividend, while paying an additional special dividend of £25m each financial year until 2021, giving a prospective yield of over 8% (variable and not guaranteed).

Provident Financial underperformed despite saying that 2017 has got off to a good start. Close Brothers was also weak despite issuing a Q3 trading update, showing solid loan book growth and stable impairments. We accept that Close Brothers is a cyclical business but it is very well managed, in our view. This, combined with the group’s specialist market positions, has translated into excellent long term shareholder returns.

Domino’s had another month to forget, following a brief revival in April. In the absence of further news, investors are still focusing on the weak start to the year reported in March. We retain confidence in Domino’s business model, but will have to wait until half year results on 25 July to get a clearer indication of whether this is a temporary blip or the start of a more worrying trend.

Imperial Brands released half year results at the start of the month which showed net sales and adjusted earnings per share declining by about 6% at constant currency. Imperial’s strategy of migrating non-core brands into a smaller number of higher quality brands is depressing sales in the short term, but we believe it is a sensible long term strategy, enabling further cost savings and investment to be prioritised behind the strongest brands.

Conclusion

It hasn’t escaped our attention that there is a UK election coming up, but as we have said many times before, we do not make decisions based on economic or political factors, and remain happy with how the fund is positioned.

In the long run, the fund’s returns will be driven by the operational performance of the businesses we own. We are encouraged by the results from our holdings in May, with all those reporting full year or half year numbers rewarding us with an increase in the dividend:

Company Results Dividend increase
Imperial Brands Half year +10%
Sage Group Half year +9%
National Grid Full year +2%
Britvic Half year +3%
Pennon Full year +7%
Paypoint Full year +6% (ordinary dividend)

Dividends are variable and not guaranteed. Past performance is not a guide to future returns.

Please note the author or his connected parties owns shares in Reckitt Benckiser, AstraZeneca, GlaxoSmithKline, Paypoint and Imperial Brands.

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Please note the author or his connected parties own shares in Ascential, Sanne and British American Tobacco.

Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.