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6 Rising Income Stock Picks from Evenlode

Evenlode's Hugh Yarrow reveals six stock picks which continue to generate healthy levels of spare cash and have the ability to sustain healthy current dividend payments

External Writer 1 June, 2017 | 1:52PM

Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Hugh Yarrow, manager of the Evenlode Income fund shares, his favourite cash compounding stocks.

Gently rising stock markets feel more enjoyable than falling ones, but they also tend to result in less compelling valuation opportunities. However, we believe reasonable returns remain available for the patient, careful investor. Also – importantly – we remain very reassured by the health and development of free cash flow for our aggregate portfolio.

We view this free cash flow stream as a key safety buffer for both the portfolio’s current and future dividend flow. We, therefore, think carefully about free cash flow, both in terms of how much is being generated by a business at present, but also the potential for free cash to develop over coming years, and how resilient it might be in less favourable economic conditions.

On this theme, I’d like to highlight six portfolio holdings, some long-held, others newer, which have updated the market recently and continue to generate healthy levels of spare cash. Encouragingly, these companies are achieving this while investing meaningfully in attractive growth opportunities.

We call a business with these characteristics a cash compounder –  a company with the ability to fund healthy current dividend payments but also possessing the potential to create a virtuous circle of reinvestment over time.

Sage (SGE)

2.6% dividend yield

1.5x free cash flow cover

Sage is a classically asset-light software business. The company released results this month which reiterated Sage’s core strategy of significant investment in organic growth; including the build out of increasingly sophisticated machine learning capabilities and sales & marketing capabilities.

As a sign of customer embeddedness, renewal rates on recurring revenue, which now represent 77% of total revenues, have ticked up steadily from 80% to 86% over recent years, forming a steady bedrock of cash flow. Sage are now looking to build on this progress with an acceleration of new customer acquisition over coming years. The latest dividend increase was 8.8%.

Diageo (DGE)

2.8% dividend yield

1.4x free cash flow cover

Diageo enjoys a portfolio of iconic brands including Johnnie Walker and Guinness, and a strong distribution footprint across both developed and emerging markets. After supply chain issues in 2014-15, the company has returned to its normal cash generative ways, helped by a shift to cash-based incentives for sales staff which is now complete.

Diageo’s low ticket repeat-purchase business model is well placed to compound cash flows over coming years, particularly given its opportunity in emerging markets, as the affordability of international brands to aspirational middle class consumers continues to grow: 730 million new consumers are expected to become able to afford international spirits over the next decade, with 85% of this growth coming from emerging markets.

Diageo’s latest dividend increase was 5% and free cash flow looks set to grow at a higher rate. As management flagged at the recent investor day, this may lead to further shareholder returns, over and above the ordinary dividend.

Informa (INF)

3.2% dividend yield

2.2x free cash flow cover

Informa owns a strong portfolio of business-to-business media brands – academic journals, digital analytics, trade exhibitions etc – which enjoy a high level of cash flow recurrence and attractive long-term growth potential.

Informa’s new management team have prioritised investment plans ahead of short-term margin expansion, which we support. These investments are beginning to pay off and drive growth. Informa’s dividend is well covered by cash flow, and the latest dividend increase was 4.2%.

UBM (UBM)

3.3% dividend yield

2.3x free cash flow cover

A new holding for Evenlode last month, UBM has a strong portfolio of trade exhibition brands. These events businesses enjoy high barriers to entry and good cash flow recurrence as exhibitors are keen to retain a presence at key industry events through good times and bad. For example, exhibitor sales proved resilient for instance, during the 2008-9 downturn.

Following a period of portfolio reshaping we are encouraged by new management’s strategy of prioritising investment in its strongest brands to drive organic growth. Our experience of this industry is that the steady, incremental expansion of existing franchises can generate very attractive compounding returns. The potential for dividend growth at UBM is good, particularly in light of healthy free cash flow cover.

Page Group (PAGE)

3.5% dividend yield

1.5x free cash flow cover

Recruiter Page Group is an asset-light people business and one of the purest ‘organic growth’ companies I have come across. Since the company began in the 1970s, it has developed its strong global position in specialist recruitment through a culture of internal development and promotion, the turnover of management staff only runs at about 5% per annum, and without having ever made an acquisition.

Though an economically sensitive business, this strategy has led to a strong compounding of cash flows over the long-term, and Page’s dividend has never been reduced. A recent trading update last month confirmed that cash continues to build up on the balance sheet. Page’s last increase in the ordinary dividend was 4.2% and the company also pays a regular special dividend.

PepsiCo (PEP)

2.7% dividend yield

1.6x free cash flow cover

Pepsi was a new holding for Evenlode last year. The company enjoys very strong competitive positions globally in both savoury snacks; Walkers, Doritos, Lays, and soft drinks; Pepsi, 7Up, Tropicana. The eponymous Pepsi brand only generates 12% of the company’s sales these days.

We continue to be impressed with the long-termist culture that has built up in the business, the returns that the company continues to generate on incremental investment and the strength and consistency of cash generation. Management recently announced a 7% increase in the dividend, representing the 45th year of consecutive dividend growth.

Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Diageo PLC2,641.55 GBX-0.26
Informa PLC740.00 GBX-0.40-
PageGroup PLC459.23 GBX0.14-
PepsiCo Inc117.80 USD0.34
Sage Group (The) PLC785.00 GBX0.51
UBM PLC745.00 GBX-0.20-
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External Writer  .