3 Stock Picks Offering Sustainable Income

Simon Gergel of the Merchants Trust tips three domestic stocks for investors looking for long term sustainable income

Emma Wall 2 October, 2013 | 7:00AM

Emma Wall: Hello and welcome to Morningstar TV. I am Emma Wall and here with me today to give three stock tips is Simon Gergel, at the Merchant Trust. Hello, Simon. 

Simon Gergel: Hello, Emma. Nice to see you. 

Wall: So, what's your first stock tip? 

Gergel: Well, I thought I'll talk about Royal Dutch Shell (RDSB), which is the largest company in the portfolio and it's interesting because you hear a very little about it, despite the fact that it's a very large oil company clearly. But the shares have tracked sideways for two or three years now, whereas the market has been going up, and they've really been neglected and almost ignored by investors to such an extent where the valuations really getting quite interesting. So the shares have been – the operational performance of business has been lackluster for the last two or three years, but it's really very long-term business. You almost have to think about Royal Dutch Shell in decades in terms of investment time horizon. 

And what they've been doing for the last decade is, building really long-term assets such as a liquid natural gas field. They've put enormous investment in upfront to generate a very steady stream of cash flow for 20 or 30 years thereafter, and that's quite different to a traditional oil field, where you drill a well and in the first year you get lots of oil out and then it declines very rapidly. So, they've been building these long-life assets and the shares really area quite cheap now. They are trading below 10 times earnings, with the dividend yield over 5%. They look very solid and the good long-term position within the trust. 

Wall: When you say long-term, does that mean the investor is going to see a massive uplift in that share price for the next couple of years then? 

Gergel: It's always very difficult to know when the returns will come through, but we always look relative to everything else in the stock market, and many of the companies in the market have been revalued. They look fully valued today. We think Shell looks very good value and that means we'll get good returns in the medium term. It's very hard to know whether that could come through next week or in two or three years' time. 

Wall: And in the meantime, you're being remunerated with a good yield? 

Gergel: Well absolutely. And I think there is a lot of risk out there in the rest of the market, which is probably underestimated. 

Wall: What's your second stock-tip? 

Gergel: Well,I thought I'd pick something a bit more cyclical. The UK construction industry is down on its knees, where there is a company called Balfour Beatty (BBY), which is one of the UK largest construction companies. They are making no money in the UK construction business today and therefore the shares are quite depressed, but we think there is a good recovery coming through. We're at bottom of the cycle. We are seeing for example the housing market picking up and that's taking some of the supplies away from the construction market back into housing, freeing up, reducing capacity and helping to make the industry bit more profitability. 

At the same time within the business, there is enormous value in their infrastructure investment portfolio, in their energy engineering consultancy business called Parsons Brinckerhoff, which is a world leader in infrastructure development and so on. They've got a large US construction business which is performing fine as well. So, there is lot of value within the business and hopefully recovery about to start within the UK. 

Wall: How linked is construction to commodities, because commodities is doing very poorly. 

Gergel: It's not really – it's much more linked to UK economic activity. So obviously infrastructure development or some of the energy infrastructure that's coming in is helpful, always seeing companies building new properties, new buildings, always seeing new housing and so on. So all those areas have been quite depressed, but hopefully we're at a turn now. 

Wall: Because the economy is picking up. 

Gergel: Because the economy is getting a bit better and they're coming out of a really, really difficult patch, yeah. 

Wall: And what's your third stock tip? 

Gergel: Well, also related very loosely to the economy is a company called Hansteen Holdings (HSTN), which is a real estate company, investing particularly in industrial property. Now, industrial property is different to prime property. If you take large shopping centres or office buildings in the City of London or West End, investors have already realised that those are attractive investments. The yields have come down. The prices have gone up and you're getting quite modest yield from buying those properties today, because they've got strong tenants. That's in the safe. 

Industrial property has lagged that cycle. Industrial properties tend to have lots of different tenants, shorter leases, more voids, more empty space and therefore much harder property to sort of manage but Hansteen has a very aggressive management team. They work their properties very hard. That means, they get – they buy portfolios with a lot of voids and they get tenants in. They work very hard to build to get tenants in to raise the income stream from those properties. 

And we think over time, not only will they be successful at bringing new tenants in, as economies recover, but also that the yield, the bond property the investors will demand will decline, people will get more optimistic, in fact we sold our properties transaction today at a lower yield. Hopefully, investors will get more optimistic and the asset value will rise as well at the time and Hansteen is largely in Germany, but also in the UK and the Germany economy as you know is doing quite well. So, space is starting to be taken up. 

Wall: Investors are nervous about property, but this isn't investing in real estate per se, is it? This is investing in a stock. So, volatility as share prices go up and down, but not the liquidity issues you'd associate with property? 

Gergel: Yes, you've got – you are investing in a company rather than investment property and the advantage of that is you get a management team who are absolutely focused and have a fantastic track record in that subsector, which is a pretty niche market, but yes, there is more volatility with the share price, because it can move around, but the liquidity should be better. 

Wall: Simon, thank you very much. 

Gergel: Thank you, my pleasure. 

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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
Balfour Beatty PLC261.80 GBX0.31
Hansteen Holdings PLC116.60 GBX0.00
Merchants Trust Ord562.00 GBX1.08
Royal Dutch Shell PLC B2,265.00 GBX-0.35

About Author

Emma Wall  is former Senior International Editor for Morningstar

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