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Miton's Moore: Where to find income in financials

06 June 2019

Miton’s Eric Moore highlights five UK financial stocks he holds in the FP Miton Income fund that are among his favourite sources of income.

By Eric Moore,

Miton Group

Financial stocks have suffered a double whammy from a rising tide of regulation and Brexit-induced anxiety. However, this has opened up opportunities for the income-orientated investor. The fact that Royal Bank of Scotland returned to the dividend list last year, for the first time since 2008, and has even paid a special dividend this year, demonstrates the nature of the improvement. Below are five of the FP Miton Income Fund’s favourite financials.

 

Lloyds Banking Group

The acquisition of HBOS in the teeth of the credit crunch nearly killed Lloyds, but now endows the group with enviable market shares in the UK, across current accounts, savings accounts, mortgages, credit cards and small business lending. These high market shares should provide a sustainable cost advantage, which is further supported by the group’s £3bn investment in digitisation to drive the cost:income ratio down further. Until recently, this high intrinsic profitability has not come back to shareholders for two reasons. Firstly, the regulatory requirement to hold ever more capital. Secondly, redress for payment protection insurance (PPI) mis-selling has chewed up a mind-boggling £19.2bn. Both of these negatives are beginning to abate. This should mean that the full earnings power of the bank can be turned towards delivering sustainable and progressive dividends to shareholders. With a prospective dividend yield of 5.0 per cent, shareholders will see good growth in dividends if the future is less eventful than the past.

 

Charter Court Financial Services

Regulatory changes have actually been a big positive driver for Charter Court. Changes to income tax deductibility and increases in the stamp duty on non-primary residences have made buy-to-let properties significantly less attractive to the ‘dinner-party landlord’. But professional landlords, who bring scale, can cope with the changes. It is these professionals that are Charter Court’s target market. At the same time, the under-writing requirements for buy-to-let lenders have been tightened up, making it a less attractive area for the High Street banks and creating space for smaller players. This has enabled Charter Court to grow their loan book by 24 per cent and their profits by 42 per cent in 2018. The company recently announced a merger with fellow mortgage specialist, OneSavings Bank. The enlarged group will have a prospective yield of 3.8 per cent and should be capable of excellent dividend growth.

 

Legal & General

It is estimated that there are over £2trn of defined benefit (DB) pension liabilities in the UK. Given half the chance, most companies would love to get out of these. Legal & General has been at the forefront of developing the pension risk transfer market to address this demand. This market is still in its infancy, but L&G estimate they have about a 30 per cent market share. They are differentiated in their ability to self-generate direct assets, such as regeneration schemes, build-to-rent property and affordable housing. In this way they are matching up long-duration liabilities (pensions) to long-duration assets (new property), and earn the illiquidity premium. They believe this is both economically and socially useful. The pipeline of new business is huge. The shares offer a prospective yield of 6.4 per cent and consensus expects the dividends to grow at over 7 per cent per annum for the next three years.

 

St James’s Place

The group provides face-to-face wealth management advice through nearly 4,000 direct advisers. Their market is large and growing, helped by the ongoing ‘advice gap’ created by recent regulatory changes such as the Retail Distribution Review and Pension Freedoms. The company has a generous dividend, offering a prospective yield of 5.1 per cent and a forecast growth in dividends of 19 per cent for the next three years. This growth rate sounds unobtainably high, but actually is pretty much nailed down. The group has about £96bn of assets under management, but £34bn of these are still in “gestation”, and not yet contributing to the cash result and so not chipping into the dividend. This is because the company does not earn anything on pension business for the first six years. So there is, in effect, a pig in the python. As this matures, the cash profits of the group has the potential to nearly double by 2024. This supports great dividend growth even without anything else happening. And of course, the group is still actually growing new business nicely.

 

Man Group

This alternative asset manager leopard has perhaps changed its spots more than the market seems prepared to believe. Before the credit crunch, the company relied heavily on very high margin products, often with guarantees, sold to retail investors, mainly linked to its AHL quantitative (or ‘black box’) strategy. But now the company is home to five separate investment management businesses, with a combined $112bn under management, and is much more institutional in nature. This transition has meant the group has lower profit margins than in the past, but is now much better placed for the future. Most of the group’s strategies embody performance fees which give the potential for significant upside if the stars align. The group has a generous dividend policy, paying out 100 per cent of management fee profits, which supports a prospective dividend yield of 5.7 per cent. The continuing interest in Man Group’s products, and lower correlation to stock market levels, should mean that this dividend can continue to grow nicely in the years ahead.

 

Eric Moore is manager of the FP Miton Income fund. The views expressed above are his own and should not be taken as investment advice.

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