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Marlborough’s Moffat: Why we’re backing overseas dividend-payers in our UK portfolio

25 October 2017

Marlborough Extra Income co-manager Andrew Moffat explains why he and the team are adding large-cap US and European companies alongside the UK stocks in their portfolio.

By Andrew Moffat ,

Marlborough Fund Managers

The UK has plenty of world-class companies, but it does not have a monopoly on them and in the current environment we believe there are good reasons to add quality overseas dividend-payers to UK-focused portfolios.

UK companies paid out a record £33.3bn in dividends in the second quarter of this year and underlying dividends, excluding an unusually high £4.6bn of special dividends, still hit a record £28.6bn, a 12.6 per cent year-on-year increase, according to the Capita Dividend Monitor. Strip out the exchange rate gains for overseas earnings resulting from weaker sterling and underlying growth was still an impressive 7.8 per cent.

Look a little more closely though and there are reasons to be wary. Take, for example, the high degree of dividend concentration in the UK market. Ten stocks represent 58 per cent of forecast FTSE 100 dividend payments for 2017, according to the AJ Bell Dividend Dashboard, which calculated that Royal Dutch Shell alone will contribute 14 per cent of those dividends.

Investors being over-reliant on this limited number of big names gives cause for concern, particularly after we have seen giants like Centrica and Tesco cut their dividends – though the latter has, of course, now reinstated its payout.

The level of dividend cover is also worthy of examination. This is the ratio produced by dividing profit after tax by the dividends paid out to shareholders and is a measure of the sustainability of dividends.

A ratio of 2.0 times is viewed as offering a margin of safety for dividend payments if there is a sudden downturn in trading either at individual company level or for the economy as a whole. A ratio below 1.0 shows more is being paid out in dividends than is being earned in profits. According to research by the Share Centre, dividend cover for the FTSE 350 has fallen to 0.8, which is a seven-year low.

We believe that a number of business areas that are mainstays of UK dividends – such as oil, pharmaceuticals and telecoms – face threats from competition, regulation and disruptive innovation. So we do not want to be overly exposed to them.

We still hold select companies operating in these areas, because they are quality companies that may well deal effectively with these challenges, but we carefully manage that exposure. To help manage stock-specific risk, we run a diversified portfolio, with more than 110 holdings and even our largest individual positions are rarely more than 2 per cent of the portfolio.

Concern about dividend concentration and the sustainability of payouts are two reasons we have been building our exposure to quality US and European large-cap equities. Another is, of course, that looking overseas significantly increases the range of opportunities open to us and provides sensible diversification in the portfolio.

We are seeking companies that are on decent yields that offer good prospects for dividend growth and capital appreciation.

In the US, we like pharmaceutical business AbbVie. We bought in earlier this year when the valuation was depressed, with shares trading on a P/E multiple of 12x because of concerns about competition for its biggest-selling treatment, Humira. This is an anti-inflammatory drug used to treat conditions ranging from arthritis to Crohn’s disease and it accounted for just over 60 per cent of the company’s revenues last year.

Now though, AbbVie has negotiated a deal that means a rival drug company, Amgen, will not launch its own version of the treatment in the US until 2023. This is a strong positive for AbbVie because the US is the largest market for the drug.


At the same time, the company has a strong pipeline of new cancer and arthritis drugs, dermatological treatments and anti-inflammatories. Based on the quality of AbbVie’s research and development work, we are optimistic some of these will be brought successfully to market. Recent announcements from the company have been encouraging, so we think the prospects are good, and we like the yield of 2.7 per cent.

Another healthcare business we like, this time a European one, is Swiss company Novartis. Chief medical officer and global head of drug development Vasant Narasimhan will take over as CEO in February and he has a clear mission to shift the company’s primary focus back to creating new drug treatments. This follows a number of disappointing years after the company switched tack away from that core business with the purchase of eyecare business Alcon.

We are encouraged by the early success of a new drug from Novartis called Kymriah, which treats leukaemia in children by using their own cells to fight the cancer, and the company has other promising products in the pipeline. This points to the strength of the company’s all-important research and development work.

Novartis has had a difficult time and its conglomerate structure, with stakes in other businesses, means it is a complicated organisation. We think though that it has strong potential and with the new CEO ready to rebalance the company we think it presents an attractive opportunity. Novartis is trading on a P/E multiple of 16x, it is cash generative and has a yield of 3.3 per cent, though that will be closer to 2.9 per cent after Swiss tax has been deducted from the dividend.

In the difficult and fast-changing world of technology, US titan Microsoft could have gone the way of IBM and Hewlett Packard, but instead it is successfully reinventing itself, with a business model far more focused on recurring revenues, through subscription-based software, such as Office 365, and its rapidly growing cloud computing services.

Cloud computing is a huge growth market globally and Microsoft’s Azure brand is second only to Amazon in the US. That puts the company in a strong position to benefit from businesses keen to manage risk by using more than one cloud service provider.

Microsoft’s brand remains strong and its valuation, with shares on a P/E multiple of around 20x, is significantly lower than for the FANG stocks – Facebook, Amazon, Netflix and Google. So we view it as a relatively inexpensive way to gain exposure to high-end tech. The yield is 2 per cent, which is difficult to find anywhere else in US tech stocks.

Another US company, Deere & Co, is best known for making tractors and agricultural equipment. Little surprise then that its share price has suffered over the last four or five years because of a cyclical downturn in agriculture in the US, which is where it does most of its business. Lower crop prices have hit farmers’ incomes and in turn reduced demand for the company’s machinery.

Looking at crop prices in a historical context though, they are around a 25-year low. We think they could start to recover and when that happens and demand for agricultural machinery ramps up, Deere and Co has a strong brand and is well positioned to reap the benefits.

In an interesting move during the summer, the company bought Wirtgen, which is a leading global manufacturer of road building equipment, providing a degree of rebalancing away from agriculture.

We also see value in the acquisition of US agricultural tech business Blue River Technology, which has developed smart machinery that sprays herbicides only where they are needed – rather than using a blanket approach.

We like Deere & Co’s high return on capital employed, its net cash and the yield of 1.7 per cent.


Frankfurt-listed Deutsche Post has cut costs and fended off competition from other parcel deliverers in its domestic market while investing successfully in its overseas businesses. Its DHL subsidiary is well established in the international delivery network and, as the global economy strengthens, stands to reap the benefits of increasing world trade to a degree that few UK businesses can rival.

The company is strongly managed and has defended its position very effectively. For those reasons we believe it is a more attractive option than its UK counterpart, Royal Mail. Deutsche Post also pays a healthy yield of around 2.8 per cent.

In conclusion then, our view is that the UK is home to many world-class companies, and these remain the mainstay of our portfolio, with exposure to overseas equities relatively modest at around 13 per cent of the fund. We believe though that given the risks to UK dividends it is only sensible to diversify by holding a selection of these quality overseas dividend-payers alongside our UK stocks.

Andrew Moffat is co-manager of the Marlborough Extra Income fund. The views expressed above are his own and should not be taken as investment advice.

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