3 Income Stocks for Cautious Investors

Jupiter Distribution fund manager Alastair Gunn does not own stocks with downside risk - preferring companies with good capital discipline who return excess capital to shareholders

Emma Wall 25 August, 2015 | 11:04AM
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Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today to give his three stock picks is Alastair Gunn, Co-Manager of the Jupiter Distribution Fund.

Hello, Alastair.

Alastair Gunn: Hello.

Wall: So what's the first stock today?

Gunn: First stock is esure (ESUR) which is a motor insurer. The reason I like this stock is that, I think it looks good value relative to the market so it trade on a P/E of about 12 times and has a very attractive dividend yield of around about 6%. Similarly the balance sheet is very strong, it has very little leverage in the business. And the reason for focusing on the stock now is that we've had two years of falling motor insurance rates.

Rates are down about 35% over the last couple years and they just started to turn the corner. They are up about 4% to 5% this year and that should continue quite markedly in my opinion, because we have an environment now where claims inflation so that’s the number of people making claims has started to spike back up again. That’s a cost for the industry.

A number of players within the industry are reporting their overall cost ratios are higher than their incomes so they are effectively reporting an underwriting loss at the moment. The transmission mechanism by which pricing changes in the market is increasingly through these aggregator websites. So rates come down quickly through these aggregator websites because there is very easy transparency of pricing, and they should go back up reasonably quickly as well in my opinion.

Wall: What's second stock today?

Gunn: The second stock is WPP (WPP). This is obviously a global advertising company, the largest in the world. I think this is starting to look good value, its trading on about 15 times which for a business which is consistently growing its earnings at around about 10% per annum is quite cheap in these markets. It pays about a 3% dividend yield. That's over two times covered, so quite healthy cover and the payout ratio, the proportion of profits that are paid out has been going up and there may be a bit more upside to come from that.

When we look forward over the next 12 months, this is a sort of a big year coming up for the advertising industry. We've got elections in the U.S., we got the Olympics coming up, there is normally a big spike in advertising activity on the back of those. And generally I think the threat from the fragmentation of advertising markets, whether it be radio, TV or increasingly towards digital, that kind of complexity for the advertisers plays into the hands of the advertising specialist.

So I think their role for their customers is getting more and more important. So that valuation is attractive, the growth in the context of what we're seeing elsewhere across the market is attractive. And they have a very strong balance sheet, so they have the ability to supplement growth through acquisitions, by product area or by geography around the world.

Wall: What's the third and final stock today?

Gunn: The third stock is easyJet (EZJ), the low-cost airline. Again I think it looks good value, it's on about 12 times earnings, it yields about 3.5% at the moment, that dividend is very well covered, 2.5 times covered at the moment. I think there is a chance we'll have a special dividend paid out early next year. So your total dividend yield could easily be 5% or 6% on a 12 month view. And the reason I like this is generally I think the airline industry is showing very good capacity discipline.

So we're in an environment where pricing power is coming through and the last set of monthly traffic figures that we saw from EasyJet, they had and 94.3% load factor, that's pretty much unprecedented. It's almost theoretically impossible to have any more people on the plane, when you think about off peak and peak travel and so, also lot of aircraft are completely full at the movement.

Wall: Presumably they are a beneficiary of falling oil prices as well.

Gunn: Yes, I mean there is some debate in the industry, whether that just gets passed back to the customer in lower prices, but because we are seeing this capacity discipline. I think actually some of that gets captured and profits benefit from that.

So I do think the risk to earnings forecast in the market are probably to the upside and generally what I think, there is great deal capacity discipline in the marketplace here. We're also structurally underpinned by the fact that this is a low-cost operator. So it should consistently be able to take market share from the old legacy flag carriers like Air France and Lufthansa who have these structurally very inefficient cost basis.

Wall: Alastair, thank you very much.

Gunn: Thank you.

Wall: This is Emma Wall from 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.

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Emma Wall  is former Senior International Editor for Morningstar