Clark says a number of the largest names in the FTSE 100 give income investors all the protection and growth they need and, due to various reasons, many of these are now looking cheap. With that in mind, he highlights three currently undervalued mega caps that he believes can increase dividend payments.
Tesco
Despite Tesco’s profits warning in 2012 and concerns about its plans for international expansion, Clark says the supermarket is a good choice for the income-seeking investor.
“Now it is out of favour, but if the management team can sort through their issues then it will become more popular with investors,” Clark said. “It is a very cash-generative and robust business.”
Clark is a big fan of Tesco and says it is a very profitable company and very competitive here in the UK. Its dividend yield is 4.6 per cent and Clark says that due to the management mistakes, it is now trading at a very good price.
Recent worries surrounding Tesco have led the stock to lose money over the last 12 months while the market has rallied.
Performance of stock vs index over 1yr
Source: FE Analytics
However, Clark doesn’t expect this trend to continue.
“We think it is still good value as Tesco’s estimated IRR (internal rate of return) is 14 per cent per year. Even if it’s just half that amount, it is still doing very well,” he added.
The manager also points out that the company’s restructuring will mean strong free cash-flow generation.
Despite the fact that it is one of the UK's 30 largest companies, only 23 funds in the IMA universe count Tesco as a top-10 holding. One of these is the five crown-rated Majedie UK Equity fund.
HSBC
Clark says that HSBC is one of the highest quality banks available to investors, and with a market cap of more than £125bn it is also the second-largest company listed on the FTSE 100.
The manager says it has a good business here in the UK and also offers decent exposure to the Far East and emerging markets. However, the main reason he holds a lot of shares in the company is because the management team’s discipline makes it an ideal buy for income investors.
“HSBC is the one UK bank that didn’t need rescuing and it is clearly well-funded as it survived the financial crisis without support. It also basically stabilised interbank lending on its own,” Clark explained.
The manager says that HSBC’s forward dividend yield is at least 5.2 per cent, which is promising for income investors. However, he is more excited about the expected dividend increase this year.
On top of that, given its link to the emerging markets, the manager says that HSBC’s valuation is looking very attractive from an historical point of view and as a result he has been adding to his exposure recently.
HSBC’s shareholders have had a tough time of it recently, however, with the stock losing money over the past six and 12 months.
Performance of stock over 1yr
Source: FE Analytics
It is still a very popular company, with more than 350 fund managers counting it as a top-10 holding.
One of its most high-profile fans is FE Alpha Manager Nigel Thomas, who has decent exposure to it in his AXA Framlington UK Select Opportunities fund.
BP
BP is Clark’s third-largest holding in his Fidelity MoneyBuilder Dividend fund.
Following the 2010 oil spill in the Gulf of Mexico and the subsequent dividend cut, income investors have generally steered clear of BP. However, Clark says that it is coming to the end of its legal issues and is now once again a safe income stock.
“It is another one that is very much out of favour,” Clark said. “We all know it has been in the news for all the wrong reasons, but we think that means that there is now very low downside risk as it is coming to the end of the litigation over the 2010 oil spill.”
The manager says that BP is looking like an increasingly good income play as the board is going to buy back £10bn worth of stock from shareholders – which roughly equates to 7 per cent of BP’s market cap.
He also says the company has a commitment to a progressive dividend, with increases expected in every year.
As the graph below shows, the 2010 oil spill hit BP’s share price hard. Although it has since recovered, it has still only made 9 per cent over the last year while equity markets around the developed world have seen high double-digit returns.
Performance of stock over 5yrs
Source: FE Analytics
Clark added: “I think it offers a safe and growing income. Now is an attractive entry point as it has a rock-sold valuation because its relative price is at a multi-decade low.”
BP is the fourth largest constituent of the FTSE and has a market cap of £94bn.
Like HSBC, it is a very popular stock with fund managers. All in all, 288 IMA funds count it as a top 10 holding, including CF Ruffer Total Return, Liontrust Special Situations, Investec UK Special Situations and Trojan Income.
