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The UK stocks with the sturdiest dividends (and the income funds that hold them): Part 2

05 August 2016

In the second of a mini two-part series, FE Trustnet highlights the 10 UK stocks to make it onto the ‘The Evenlode Sustainable Dividend Report’ as well as the UK equity income funds that hold them.

By Alex Paget,

News Editor, FE Trustnet

In an article published earlier this week, the co-managers of the five crown-rated Evenlode Income fund Hugh Yarrow and Ben Peters warned that the outlook for UK dividends is full of uncertainties.

The duo’s major concern is that many companies will have to join the already substantial list of companies that have had to cut their dividends over the past 18 months or so due to poor earnings growth and falling levels of dividend cover – though they have also warned in the past that even high quality stocks will struggle to keep up strong dividend growth in the future thanks to a poor economic backdrop.

Though this suggests a tough few years for UK equity income stocks, in their ‘Evenlode Sustainable Dividend Report’, they highlighted 10 stocks they believe have the strongest dividend potentials.

To whittle down the list, they analysed each UK stocks’ dividend sustainability and dividend growth potential using its free cash flow.

To make the final cut, each of the companies featured in the report have strong cash flow return on invested capital, low or no debt, strong free cash flow cover, a long-term track record of growing dividends, a market cap of £500m, at least two years of dividend cover and a current dividend yield of more than 2 per cent.

 

Source: The Evenlode Sustainable Dividend Report

In the previous article, we highlighted five of the UK companies to make the grade – as shown in the table above. Here, we look at the remaining five stocks and the UK equity income funds that hold them.

 

Spectris

First up is Spectris, the FTSE 250-listed instrumentation firm that is a market leader in the precision instruments and controls sector.

The £2.2bn company has an unexceptional dividend yield of 2.9 per cent, but Yarrow and Peters believe it to be an attractive income stock given its five year average dividend growth rate stands at 12 per cent per annum.

“[Spectris’] products typically represent a very small part of the customer’s cost base but can have a material impact on a customer’s efficiency and product quality. Sector exposure is broad with end markets ranging from biotechnology to energy,” Yarrow and Peters said.

“Spectris benefits from a reputation going back decades, intellectual property, research and development expertise and a strong distribution network.”

“The business consistently turns profits into cash and its balance sheet is strong. Spectris’s most recent dividend increase was +8 per cent. Spectris has grown its dividend by 10 per cent per annum since its flotation in 1988.”

Despite that, shares in Spectris have struggled over recent times and (despite the odd rally) have lost 9.11 per cent of their value over three years.

Performance of stock versus index over 3yrs

 

Source: FE Analytics

As such, it isn’t too surprising that only one IA UK Equity Income fund counts it as a top 10 holding (OLIM UK Equity Income), though a number of mid-cap funds in the IA UK All Companies sector have big bets on the stock.

 


RWS Holdings

RWS Holdings, with its market-cap of just £500m, is the smallest company to feature on this list. This is probably why MI Chelverton UK Equity Income, which focuses on small and mid-caps, is the only member of the peer group to hold it as a top 10 position.

However, the Evenlode duo says RWS – which is a specialist in intellectual property support services, and the global market leader in patent translation – says the management’s progressive dividend business and its cost effective business model mean it is a top option for income investors.

“RWS provides a service that is essential for the smooth and efficient functioning of a company’s innovation efforts, but whose cost is very small relative to the total cost of overall expenditure on research and development.”

“RWS is an asset-light, highly cash generative business with a very strong balance sheet. The company has grown its dividend every year since its flotation in 2003.”

Despite the general underperformance of mid and small-caps over recent times due to Brexit uncertainty, RWS has managed to buck the trend with its shares having rallied a hefty 80 per cent over 12 months.

 

Unilever

This is probably one of the best known UK-listed stocks, given Unilever’s brands include Dove, Pot Noodle, Marmite and Ben & Jerry’s.

Though the stock has performed very well over the longer term, one of the major criticisms of Unilever is that it is one of the so-called ‘expensive defensives’ (or high quality divided-paying stocks that have been bid up to high valuations thanks to low yields on offer from bonds).

As the graph below shows, its share price movements have been highly correlated to the drop in 10-year UK gilt yields over recent years.

Performance of stock versus indices over 7yrs

 

Source: FE Analytics

However, though Yarrow and Peters note that its dividend yield is low compared to the wider market at 3 per cent, it has been growing its pay-outs at a decent level and will also benefit from a weaker pound.

“One of the classic dividend growth stocks in the UK market with roots going back to the 19th Century, Unilever owns a portfolio of global brands including Dove Soap, Lipton Tea and Magnum ice creams.”

“This low ticket, repeat-purchase business model has helped drive dividend growth of +10 per pent annum over the last 50 years and the company recently increased its dividend by +6 per cent. Unilever is globally diverse and has the financial strength to continue investing in its brands and distribution network to strengthen its competitive position and help drive long-term growth.”

Unilever is a highly popular stock with UK managers. According to our data, 71 funds from the two main UK equity peer groups count it as a top 10 holding, with 19 of them hailing from the IA UK Equity Income sector.

Those that have big positions in the stock include core funds like Fidelity MoneyBuilder Dividend, Threadneedle UK Equity Income and Trojan Income.

 


Spirax-Sarco

Spirax-Sarco, the FTSE 250 index engineering firm, is by no means as a widely held as Unilever – in fact no UK equity income funds hold it in their top 10.

The Evenlode duo say this is strange, though, given the stock’s income credentials. While its 40 per cent share price rally in recent months has forced the dividend yield to just 2 per cent (the lowest possible for the report), it has grown its dividend at more than 8 per cent per annum over the past five years.

This, along with next to no debt and a progressive dividend policy, makes Spirax-Sarco highly attractive, according to the report.

“A high quality engineering franchise based in Cheltenham with a remarkable 48-year record of dividend growth,” Yarrow and Peters said.

“Spirax has a dominant global position in the niche market of steam and thermal energy management, providing products that help customers make their industrial processes more efficient and improve product quality. Customers range from food, beverage and pharmaceutical manufacturers to power stations.”

“A large proportion of sales come from spare parts and maintenance, providing a resilient cash flow stream. Spirax has no debt and has a record of paying special dividends to supplement its ordinary yield when cash builds up on the balance sheet.”

 

Victrex

The final stock on the list is also not represented in any IA UK Equity Income fund’s list of top 10 holdings, though 10 portfolios across the IA UK All Companies and IA UK Smaller Companies sectors do have large relative stakes in the business.

Victrex, the FTSE 250-listed chemical and industrial group, currently has a dividend yield of 3.9 per cent and has grown its dividend (which is well-covered) by 13 per cent over the past five years on average.

Though its share price is down more than 17 per cent so far this year due to pre-tax profits falls, Yarrow and Peters believe Victrex to be a high quality company that can grow shareholders capital and income over time.

Performance of stock versus index in 2016

 

Source: FE Analytics

“Lancashire-based Victrex is a global leader in high performance polymers, materials that have several advantages over metal in applications such as planes, cars and medical implants.”

“Its products help customers save money, reduce production time and improve the performance and efficiency of their products. Victrex generates strong cash flow and has no debt, and has a clear policy to pay special dividends when cash builds up above a certain level on the balance sheet.”

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