Five-star rated managers of the Evenlode Income fund have picked 10 UK stocks they think will deliver sustainable income to investors over the next five years. Co-managers Ben Peters and Hugh Yarrow have focused on free cash flow to screen out top companies that can afford to reward shareholders over the medium term.
In the Evenlode Sustainable Dividend Report 2016 released today, the managers concede that the outlook for the UK dividend market is “very mixed”, noting that several companies have cut or reduced their pay-outs over the past year, especially in the energy, mining, supermarkets and utilities sectors.
“A variety of factors have led to these cuts: industry difficulties, large capital investment requirements, poor cash generation and high debt levels,” the report reads.
“The recent UK referendum result may also affect the UK markets future dividend payments. UK domestic sectors such as banks, commercial property, construction, house builders and retailers may find it more difficult to sustain or grow dividends.”
The managers warned investors against companies with negligible or negative free cash flow, saying that they should expect these companies to cut dividends in the future, as current pay-outs were being funded by borrowings.
Looking at debt-light, cash-rich companies with a yield of 2% or more and a history of growing dividend pay-outs, the managers identified 10 stocks for income investors over the next five years.
“Even the highest quality company is not a good investment at too high a starting valuation. Balancing attractive dividend growth with a solid starting yield is the key to income and growth investing,” said Peters. “We have filtered UK listed companies with a minimum market capitalisation of £500m for companies offering a dividend yield of more than 2%.”
Below we list the companies and the Morningstar analyst view of the stocks where there is coverage.
Sage has a large footprint in the global small and medium business software industry. However, a changing competitive and technological environment has seen the company struggle to keep up with peers because of a muddled cloud strategy, decentralised organisational structure, and inability to leverage common technology across geographies, according to Morningstar analyst Andrew Lange.
He believes these factors have led to a weakening competitive position. While the shift to online rivals poses a significant long-term risk, over the midterm he believes Sage will continue to perform well thanks to a trove of loyal existing customers and a new strategic plan aimed at refocusing and centralising operations.
Fidessa (FDSA)
Yield: 1.5%
Fidessa Group provides multi-asset trading and investment infrastructure, market data and analysis, and decision making and workflow technology.
PayPoint (PAY)
Yield: 4.09%
PayPoint is a service provider for consumer transactions through distribution channels, involving the processing of transactions, the management of retailers and clients, the settlement of funds by the application of technology.
Page Group (PAGE)
Yield: 3.29%
PageGroup PLC operates as a specialist recruitment consultancy. The Company provides recruitment services for permanent, contract and temporary staff at clerical professional, qualified professional and executive level.
Compass (CPG)
Yield: 1.9%
Compass Group is one of the largest and most entrenched food-service providers. Its extensive global footprint serves a diversified mix of sectors and geographies, providing the foundation for a narrow economic moat that generates consistent revenue streams and healthy cash flow says Morningstar analyst Michael Field.
Combining this dynamic with an asset-light operating structure leads to strong returns on invested capital. Demand for Compass' services is moderately tied to both consumer and enterprise-level discretionary spending, which adds some cyclicality. Nevertheless, Compass appears well positioned to grow as enterprise-level outsourcing gains traction for the longer term.
Spectris (SXS)
Yield: 2.54%
Spectris designs, develops and markets productivity-enhancing instrumentation and controls. Its businesses are grouped into four segments: materials analysis, test and measurement, in-line instrumentation and industrial controls.
RWS Holdings (RWS)
Yield: 1.83%
RWS Holdings provides translation, intellectual property and language support services. It has four segments including patent and commercial translations UK, and patent and commercial translations overseas, information, and inovia.
Unilever's scale and scope give it competitive advantages, and with 58% of sales generated in emerging markets, the firm offers substantial exposure to growth markets. However, although analysts view the shift in emphasis to personal care from packaged food as a net positive, analysts expect Unilever to have limited success in expanding its volume and margins simultaneously, given the highly competitive nature of its categories, says Morningstar's Philip Gorham.
Management's stated objective is to achieve organic sales growth, driven by volume, at an above-market rate; analysts view this as an appropriate strategy that is likely to consolidate the firm's moat over time.
Spirax-Sarco (SPX)
Yield: 1.66%
Spirax-Sarco Engineering is an industrial engineering company. It offers engineered solutions for energy and water savings, reduced emissions, process efficiency, product quality and improvements in plant health, safety and regulatory compliance.
Victrex (VCT)
Yield: 3.08%
Victrex is a manufacturer of thermoplastic polymer solutions. The Company's business segments are Victrex Polymer Solutions and Invibio Biomaterial Solutions.
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