A year from now we’ll hopefully have an idea of what Brexit will look like. Almost any outcome seems possible, and our choices reflect that uncertainty.
Income features prominently. Unlike share prices, dividends are comparatively stable, although not guaranteed.
We hope this provides food for thought in a crucial year for the UK economy.
This article isn’t advice or a recommendation to buy, sell or hold any investment. Yields are variable and not an indicator of future income.
AG Barr – quality at reasonable value
AG Barr's drinks range stretches from Rubicon to Tizer. But the luminous orange Irn-Bru is by far the most important.
The Glaswegian tonic ‘made from girders’ is one of a tiny number of soft drinks to have denied Coca-Cola top spot in its home market. On sale since 1901, a unique flavour and irreverent marketing means Irn-Bru continues to grow.
There were fears the government’s new sugar tax, plus an increasingly health-conscious consumer would weigh on Irn-Bru sales. But loyal customers seem to be switching to the zero sugar version, which sold the equivalent of 20m cans in its first six months.
The Barr family remain heavily involved in the business. Former chairman Robin is a non-executive director, and they collectively own 18% of the company. Of the three individuals who know the top-secret Irn-Bru recipe, two bear the Barr name.
We like companies with significant family ownership. The desire to pass the business on to the next generation usually means a long-term focus.
That might explain why AG Barr is debt-free and has grown or held the dividend every year since the late 90s. The prospective yield is 2.6% in 2018/19, although this isn’t a reliable indicator of future income.
AG Barr may lack the stellar growth potential of a company like Fevertree, but revenues are up 8.8% so far this year. The group trades on a price-to-earnings ratio only 7% above its long-term average, at a time when many rivals are on valuations with a bit more fizz.
Dividend per share (GBp)
Past performance is not a guide to future returns. Source: Thomson Reuters Eikon, 27/11/17
Legal & General - a healthy dividend with scope to grow
We think Legal & General can offer a sizeable dividend today and future growth.
L&G provides life insurance and retirement services to over 10m people, mostly in the UK. An aging population has driven growth, but L&G has impressed us by latching on to wider trends.
It was an early entrant into low-cost tracker funds, and now manages £331.5bn of index trackers. Companies are now required by law to provide pension schemes, and simple, low-cost funds are popular. L&G already has 2.2m personal pension customers, and employer and employee contributions are set to rise.
L&G also has an opportunity in final salary pensions, where many schemes are in deficit. By creating investments that match future pension payments and, increasingly, buying out schemes altogether, L&G helps address that problem. The market is potentially worth £2 trillion in the UK, and L&G is looking to expand in the US too.
All this is set to drive growth. Recurring revenues should make profits fairly predictable, helping to underpin the dividend. The prospective yield is 6%.
Breakdown of aggregate total wealth in the UK
Source: ONS, 2015
British Land – Brexit exposure but long-term income
British Land owns properties including shopping centres from Glasgow to Plymouth, and prime central London offices. Together, they cover an area equivalent to 328 Wembley pitches.
The group is a Real Estate Investment Trust, or REIT. This means it’s required to pay out 90% of rental profits as dividends, which can make for an attractive income.
Occupancy is at 97.6%, and the average lease has eight years left to run until first break. This means revenue visibility is high, and the high quality, blue-chip tenant base should provide some immunity to downturns.
However, with lots of exposure to financial services, and the weaker pound squeezing consumers, Brexit fears are weighing heavily. Asset values have so far proven resilient, but a retreating share price means the shares trade on a price to book value of 0.7 times, a 20% discount to its longer-term average.
The depressed share price has lifted the prospective yield to 4.8%. Those in search of an income, and prepared to weather Brexit-induced volatility, might wish to consider British Land. The company clearly thinks its shares are good value, reinvesting proceeds from recent sales in a £300m share buyback.
British Land Net Asset Value Per Share (GBp)
Past performance is not a guide to future returns. Source: Bloomberg, 27/11/17
Sophos – benefit from the cyber threat
A string of high-profile hacks mean the consequences of not investing in cyber security are all too evident.
Perhaps no surprise then, that companies are scrambling to shore up their defences. Sophos’s software helps protect small and medium-sized businesses.
The group uses a network of over 30,000 independent partners to sell its products to over 100m users in 150 countries. The market is worth in the region of £40bn, and growing quickly.
Contracts run for up to five years, retention rates are impressive and last year Sophos generated an average of 29% more business from contracts up for renewal.
At present, the group is focused on investing in future opportunities, rather than paying dividends, meaning the prospective yield is just 0.8%.
Sophos’s potential hasn’t gone unnoticed by the market though.
The shares have enjoyed a strong run recently, and trade on a premium valuation of 85 times expected earnings. If the company fails to deliver on the market’s high expectations, the share price could suffer.
However, part of the reason the rating is so high is due to accounting conventions dragging near-term earnings down. The costs of winning a contract are accounted for up-front, but revenues are spread over the life of the deal. This meant last year’s adjusted profits were just $38m, but free cash flow was $133m.
We often look at a company and say profits look great, but where is the cash? With Sophos, in the short-term at least, it’s the other way round. Given the choice, this is how we’d like it.
Number of customers since listing in 2015
Past performance is not a guide to future returns. Source: Sophos 2017 Annual report
Burberry – a new strategy to deliver shareholder returns
Burberry is a well-established luxury name, but new CEO Marco Gobbetti has plans to reposition it into what he calls the 'most rewarding, enduring segment of the market' – the very top end.
The new man should be on home territory here, having driven progress at French label Céline before joining Burberry.
The attractions of this strategy are clear.
Top-end customers are usually either fabulously wealthy or determinedly aspirational. High-end fashion can therefore mean even higher margins.
Nothing comes free though. Elevating the brand to the next level requires sharpening the premium image of its stores and removing the brand from several 'non-luxury' outlets.
This means sacrificing profit and revenue in the short term. Both should accelerate from 2021, but revising down near-term growth forecasts didn’t go down too well.
Nonetheless, we’ve never thought chasing short-term approval should be prioritised over long-term returns.
The new strategy should benefit from plenty of long-term tailwinds. Burberry’s well-placed to profit from increasing affluence in the Far East, and the £800m+ of year-end net cash on the balance sheet gives it a wealth of options for expansion, as and when the time is right.
For now, this cash pile should enable it to keep returning cash to shareholders through a dashing combination of buybacks and dividends. Burberry has a £300m buyback programme in place and the prospective yield is 2.3%.
All in all, we like the direction Gobbetti wants to take Burberry in, and applaud his willingness to take tough decisions to get the firm on the right track.
Regional mix of Burberry sales
Source: Burberry 2016/17 Annual Report
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed and are correct as at 30/11/17.
Investments rise and fall in value so investors could make a loss.
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 disclosure for more information. Nicholas Hyett owns shares in Legal & General plc.
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