EquitiesSep 10 2014

Rlam’s Cholwill backs GlaxoSmithKline

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UK equity income manager Martin Cholwill has been backing GlaxoSmithKline in his £1.4bn fund in spite of the pharmaceutical company reporting disappointing results.

The manager, who runs the top-performing Royal London UK Equity Income fund, said he had been wary of the stock for a few years based on fundamentals, such as cashflow. Now, however, it was one of his largest holdings.

The move comes in spite of the company in July cutting its 2014 earnings outlook after sales fell 13 per cent, a drop that was greater than analysts’ expectations.

GlaxoSmithKline’s share price fell 11.5 per cent from £15.57 on July 21 to £13.77 on August 7, following weaker-than-expected results for the second quarter. The share price has since rallied to £14.47.

The stock began featuring in Mr Cholwill’s top 10 in April and has now grown to one of his largest holdings, thanks in part to the manager increasing his holding in July.

“I had been cautious on the stock for a few years,” he said.

“I was uncertain about the sustainability of its dividend and its cashflow, but now it is one of my top-three holdings.”

Mr Cholwill said he was confident the stock would grow modestly in the next few years and expected the 5.7 per cent dividend yield to be “entirely sustainable” given the company’s cashflow cover and declining debt.

The move to target a mega-cap stock is a change in tack for the manager. A year ago Mr Cholwill told Investment Adviser he was most bullish on the mid-cap sector of the market.

“If you believe stockmarkets can do well, why would you want to be in the big stocks,” he told the magazine in April last year, adding that “GlaxoSmithKline and some of the tobacco stocks have suffered downgrades, while mid-caps have seen modest upgrades”.

The manager still has roughly 38 per cent exposure to mid-cap stocks, so while his move towards mega-caps might be seen as more defensive, he still has a large exposure to small- and medium-sized businesses.

This mid-cap bias has benefited Mr Cholwill, given the FTSE 250 index has returned 106.4 per cent in the past five years. During the same period, the FTSE 100 has delivered 66 per cent, according to data from FE Analytics.

The fund has swelled in recent months, surging from £534m at the end of September last year to £1.4bn at the end of July, according to data from FE Analytics.

The manager has delivered a top-quartile return in the IMA UK Equity Income sector across one-, three- and five-year periods, according to data from FE Analytics.

Elsewhere, Mr Cholwill said he was avoiding companies that could be affected by politics, including financials.

“We are in an intense regulatory environment for banks,” he said.

“Before the credit crisis it was more of a free market economy, but now politicians are more interventionist.”

The only bank Mr Cholwill holds is HSBC, which he refers to being more “American than European”.

“HSBC is financially strong, with a balance sheet strength more typical of a US bank rather than a European bank. It has lower gross leverage and already made greater loan-loss provisions than a typical European bank,” he said.

Mr Cholwill added that he was also avoiding companies that benefited from government subsidies, such as rail and bus companies and renewable energy.

“Politicians come and go,” he said. “They often make long-term promises, which there is no way they can keep because they won’t be in office that long.”

What has happened with Spanish energy companies serves as a warning of how the fortunes of these firms can plummet due to wavering government decisions, said Mr Cholwill.

Spanish renewable energy companies saw their stocks tumble after the government announced plans to cut their subsidies in July earlier this year.