InvestmentsSep 15 2017

Henderson’s Smith looks to UK consumers for income

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Henderson’s Smith looks to UK consumers for income

The outlook for the UK economy may be uncertain in a world after Brexit, but valuations of UK domestic shares are a “long-term buying opportunity”, according to David Smith, who runs the £300m Henderson High Income Investment Trust.

Mr Smith, whose trust has a yield of 4.8 per cent, said one of the key considerations in his investment process is valuation - what the current share price implies about the quality of a business and its future prospects.

On the UK he said: "I agree that the outlook for the UK is uncertain but I would also argue the risks are already well known and hence valuations reflect this uncertainty."

He cited research from Barclays which indicated that UK domestic cyclical shares, that is, companies that perform better when the UK economy is doing well, are the cheapest they have been since the global financial crisis.

He said the outlook for the economy may not be as bad as first feared, with low unemployment, consumer leverage remains below previous peaks, and in his view, there seems to be signs of wage growth.

Mr Smith said companies with an exposure to the UK domestic economy that have reported results in recent months, such as Next and Pets at Home, have produced numbers much better than had been expected by analysts.

Mr Smith said: “Although the fears over the UK economy may play out, I feel the share price underperformance in certain domestic companies has presented an attractive buying opportunity for some good quality albeit cyclical businesses."

He cited Whitbread and Lloyds Banking Group as examples of domestic stocks in which he is interested.

Of Whitbread he said the company, which is the owner of Premier Inns and Costa Coffee, “has leading market positions, strong brands, a robust balance sheet and is underpinned by freehold property".

"The company still has good opportunities to expand the business through the roll-out of its key brands which should drive higher profits over the longer term.”

On Lloyds he said the company “has transformed itself from the previous downturn into a well-capitalised bank generating good returns and attractive cash flow".

"Despite fears over pressure on margins given the low interest rate environment, the bank continues to grow net interest margins - the difference between the interest it pays to its lenders (i.e. depositors) and the interest it receives from its borrowers - while producing excess capital."

He said he expected the bank will soon be paying a dividend of close to 8 per cent.

Eric Moore, who runs the Miton Income fund, said investors should be focusing on areas of the market currently out of favour, to find future income growth.

He said the fashion for investing in companies with overseas earnings has been a major trend in the UK since the EU referendum vote, but while dividends paid in dollars have been worth more to sterling investors, those gains will diminish in time.

Mr Moore said: “The international nature of the largest UK stocks means the weak pound has been a boon for dividend growth.

"Many FTSE 100 companies, such as BP, declare their dividends in US dollars. For a UK investor, these are now worth 15 per cent more than they were before the Brexit vote.

"However, as the calendar rolls on, this boost annualises out and investors will be more reliant on underlying dividend growth. In the case of BP, mentioned above, this is currently close to zero.”

He added that he sees growth in the mining sector, where sentiment remains somewhat negative, and among insurance companies such as Legal and General, which can benefit from changing demographics as people need to save more for old age.  

David.Thorpe@ft.com