Oldfield Partners' 3 Top Income Stock Picks

Overstone UCITS Equity Income has upped the weighting to UK domestic names since the Brexit vote. Here the co-managers share three income picks

David Brenchley 24 August, 2018 | 2:40PM
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tobacco, British American Tobacco, Philip Morris, dividends, stock picks, yield

Brexit is a divisive issue among investors. Some see it as a reason to shun UK equities, others see it as an opportunity to pick up high quality stocks on the cheap.

Many global equity income investment trusts have decreased their exposure to UK stocks significantly in the past 10 years, as opportunities in Europe and the US look relatively more compelling.

But the managers of the £85 million TM Overstone UCITS Equity Income fund, run by Oldfield Partners, have have upped their weighting to UK domestic names since the Brexit vote.

“The flip side of the US looking expensive is the UK, particularly post-Brexit, is looking quite attractive from a value perspective ,” says co-manager Richard Garstang.

Britvic (BVIC) and Bovis Homes (BVS) were a couple of the additions made immediately post the referendum when share prices were sent to extremely depressed levels.

While the team have since take profits on the housebuilders, they shared two UK stocks they have most recently bought, and one US firm.

BT (BT.A)

One of the UK stocks is telecoms operator BT, which has had a fall from grace in recent years, with the share price slumping from a 15-year high £5 almost three years ago to just 225p today.

“Only three years ago, BT was trading on about 14 times price/earnings and was the most loved telecoms operator in Europe,” says co-manager Samuel Ziff. “It’s today trading on 8 times price/earnings and is the most hated telecoms operator in Europe.”

That’s hard to believe for a cyclical business. “Three years shouldn’t make that much difference to the long-term fundamentals of a business with a 20-year investment cycle,” he adds.

But it has, and that has given the fund managers the chance to pounce. The massive 7% yield is “incredibly attractive” and gives them the chance to be paid while they wait for the value they believe BT has to be realised.

Of course, there are hurdles along the way. The regulator is trying to curb BT and Virgin’s dominance of fibre networks by creating a third network to service around 40% of the country. But Ziff says it’s going to be hard for any start-up companies to make inroads into the scale of BT’s estate.

Fundamentally, fixed-line broadband is always going to be in demand – and if it does fall out of favour sooner than expected, BT also owns the largest mobile provider in the UK, EE.

“There’s a lot of unknowns that clearly hurt the share price and the sentiment towards the company, but we think they’re in a good position as that plays out,” adds Ziff.

IWG (IWG)

They also like IWG, the UK-based office work place provider formerly known as Regus, which has been in talks with numerous private equity companies about a potential takeover of the company for a while now. However, recently the company confirmed none of the three it had been speaking to had tabled an acceptable offer.

As a result, the share price has been pretty volatile, jumping a third back in May before reverting to its previous price earlier this month.

The attractions of IWG are clear. It’s the clear leader in the space, with around four times the revenue of WeWork, its start-up competitor.

Despite that, WeWork is clearly more fashionable right now, with the privately owned US firm valued at $20 billion compared to IWG’s £2.2 billion. WeWork may be growing substantially faster than IWG, but it’s still a loss-making venture.

Only around a third of IWG’s revenues come from the UK, meaning it’s insulated from its home country’s flagging economy. Despite that, sentiment’s been hit just as badly as others more reliant on the UK

And Garstang is still excited about the story, noting the bid interest “has to tell you there’s some value there”. Private equity firms generally target an internal rate of return of 10-15%. While they would be able to put more leverage into the business than the public market can, “you should be able to see some pretty substantial returns over the next few years”.

The pair back management, with founder and chief executive Mark Dixon’s 25% stake aligning him with the rest of the shareholder base. “He’s been pretty clear throughout that if a price was on the table that he felt was high enough he would probably sell,” says Ziff.

He points out that Dixon has cashed in at the right price before, most recently in June 2017 when he dumped 27 million shares at £3.45 each, pocketing him £94 million. More importantly, that suggests he values the business at almost 50% more than the market currently does.

A yield of 2.5% on a firm trading at 11-12 times earnings and growing its fleet of workstations at low-to-mid-teens “is incredibly cheap for a business with those characteristics”.

Philip Morris (PM)

Tobacco companies have had a tough few years, with investors beginning to question the future of the industry thanks to Governments around the world cracking down on nicotine-based products. Sentiment towards the sector’s names, including the UK’s Imperial Brands (IMB) and British American (BATS).

As a result, tobacco makers became extremely cheap. A number of income-focused fund managers have confirmed they looked at adding exposure to these firms.

Oldfield Partners did, too, concluding that, despite other names being cheaper, Philip Morris was the one that attracted them the most. Garstang explains: “A year ago it was on 22 times earnings with a lot of excitement around its heat not burn product doing well, particularly in Japan.”

But that excitement evaporated quickly. A “minor profit warning” ensued back in April, with the company telling investors its vaping products weren’t growing quite as quickly as everyone had thought they would.

The stock fell 20% in a matter of days, and ended up trading on around 15 times earnings. “Paying a 5.5% dividend on 15 times with what we still think is quite an attractive growth profile, good cash flow generation, a better balance sheet than peers and a leading alternative tobacco product gave us an interesting opportunity,” says Garstang.

Meanwhile, it’s another firm that does little business in its home market, with sister firm Altria (MO) taking care of its US products. This allows Philip Morris to concentrate on the faster-growing markets in both emerging countries as well as developed areas of Europe and Asia.

Since inception in December 2011, the TM Overstone Equity Income fund has delivered returns of 118%, narrowly ahead of the Investment Association’s Global Equity Income sector at 110%.

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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David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk