TRANSCRIPT: EPISODE 221
3 November 2022 (pre-recorded 31 October 2022)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
Sam Slator (SS):
I’m Sam Slator from FundCalibre, and today I’ve been joined by Matthew Page, co-manager of the Guinness Global Equity Income Fund. Hi Matthew.
Matthew Page (MP):
Hi Sam.
(SS):
So, let’s perhaps start off with the dividends of the companies that you hold within the portfolio. How are dividends holding up this year?
(MP):
[00:27] Well, they’re holding up very well. So, as you know, we own 35 companies in our portfolio, and so far this year, we have had dividend updates from 32 out of those 35 companies. And I’m pleased to say, we’ve had no dividend cuts, and we’ve had no dividend cancellations.
We’ve had five companies who’ve kept their dividend flat this year, and we’ve had 27 companies that have announced dividend growth for 2022 versus 2021. So, I think that’s really encouraging. It shows that despite everything that’s going on, you know, dividends are a sort of longer-term reflection of a company’s profitability, as opposed to earnings, which can be more volatile.
I think it shows that these companies are growing their dividends still, even though we are in this much higher inflationary environment, and they’re confident to continue to do that because of the pricing power that these companies have got. They’re able to pass on these higher input costs ultimately on to the customers.
And so, on average in the portfolio, we’ve seen 7.7% dividend growth from the holdings, and if you look at just the 27 that have actually announced growth, then it’s more like 9.1% which is really pretty strong. And sort of a bit of an acceleration, I think from what we saw last year.
And one of the areas where we’ve seen some of the strongest dividend growth, is actually within our financial holdings. So, a company like Aflac, for example, which is a US-listed company, but with a big Japanese insurance part of its operations, has grown its dividend 21% this year. And then we’ve seen companies like BlackRock, the asset manager, that have grown at 18%. So, you know, really impressive dividend growth despite the difficult macro environment that we’re in at the moment.
(SS):
And you mentioned there, the difficult macro environment, what are companies saying about next year? Are they concerned at all that if we go into a global recession, they might have to stop growing those dividends or even cut?
(MP):
[02:36] Yes, there’s certainly a bit of a mixed picture out there. I think if you are looking at discretionary spending, that’s where we’ve seen some of the weaker results amongst companies, but we’re quite well positioned from the point of view that we only have one of our 35 companies in the consumer discretionary space, which is a company called VF [Corporation], which owns brands like Timberland and North Face. And they’ve grown their dividend every year for over 25 years, I think it is now. So, despite them having a trickier time at the moment, broadly speaking, I think their dividend outlook looks okay.
You know, on the plus side, we’ve got a very high exposure to the consumer staples space where we’ve seen some really strong pricing power coming through. So, on average in the second quarter, these companies grew their revenues by 12%. And if you break down that 12% to how much of it has come from them putting up their prices, and how much of them has come from them increasing the volumes of goods that they sell, then out of that 12 [%], 9% has come from increased prices and 3% from increased volumes.
And that’s really interesting because, you know, normally kind of your standard economics would tell you, that if you put your prices up by 9%, you’d expect your volumes to go down. But what these companies have been seeing in the second quarter, is that that hasn’t been the case. They’ve been putting prices up, and actually people have been buying more.
And if you drill into a company like Diageo that actually delivered 20% or 21% revenue growth in the second quarter, then they’re seeing even faster growth from some of their super premium products, so their expensive whiskies and things like that.
So, I think it is still a mixed picture, and I think some of our more cyclical companies in the industrial space for example, are maybe a little bit more exposed to the effect of higher interest rates and therefore the higher funding costs of big projects.
But also, they’re very – the ones we own – are very well exposed to, you know, some key long-term themes, like energy efficiency. So, companies like ABB in Switzerland and Schneider Electric in France, are really well positioned to actually be part of a solution to the energy crisis that many countries are struggling with at the moment.
(SS):
And I notice you don’t have some holdings in areas like utilities, energy, telcos. Is that because you don’t think they can sustain their dividends or is there another reason behind that?
(MP):
[05:13] So, it really comes from the starting point for our investment process, and we take a slightly different approach. You know, we don’t start by just screening for high dividend yield and then deciding what we’re going to pick from that. We start from the point of view of looking for companies that we think are going to be able to pay sustainable and growing dividends over an entire business cycle. And therefore, what that does is, it tends to steer us away from highly regulated industries.
So, you know, a utility, for example has been given this sort of oligopolistic competitive advantage. And, in return for that, those companies are not allowed to earn high levels of profitability, year on year on year. So, as a consequence of that, they tend to get screened out of our universe. And the same would also apply to banks for that reason. It’s because they’re just incredibly cyclical; banks, sort of by definition, absorb a lot of shocks during a recessionary period, and therefore they’re not going to earn that consistency of profitability for us.
So yep, it really is all about that starting point, and looking for companies that can sustain dividends but also grow and reinvest in their business, which in turn will lead to that dividend growth over time.
(SS):
And you’ve also got quite a high weight into US companies at the moment. Why is that?
(MP):
[06:41] Yes, so we’re around, we’re probably over 50% in the US at the moment, but that’s still underweight relative to our benchmark, the MSCI World [Index], which is more like sort of 72% in North America. But it’s fair to say for a dividend strategy, that is a high weight. And I think again, that slightly comes back to that different approach.
Normally, US companies tend to pay lower dividend yields than European and UK companies, for example. And the reason for that, is they tend to return cash to shareholders partly in the form of a dividend, but also partly in the form of a share buyback. And therefore, that means that the dividend yield tends to be lower than European companies. But what we find is that, because of that, they actually have very well protected dividends. So, through the pandemic, for example, where we saw half of European and UK companies cut or cancel their dividend in 2020, actually we saw some really strong dividend growth from North American companies. So, whilst the yield might be lower, the sustainability and the growth there is very attractive.
(SS):
Bonds haven’t really paid a decent income for quite a few years now, but we’ve seen the yields on them rise quite significantly over the last few weeks. What would you say to investors who are thinking, maybe I’ll get my income from bonds now instead of equities?
(MP):
[08:10] Yeah, I think it’s a really interesting point, and I think the key point to remember about your income from your bonds as opposed to your equities, is the fact that, of course, your income stream from your bonds doesn’t grow. And therefore, if you are worried about protecting that income stream from inflation, you really need to be looking for an income stream that is going to be able to grow over time.
And therefore, you’ve got to look at that balancing act of, what is better? Say a 3% yield that is flat every year for the next 10 years, or a 2.5% yield that can grow at 7% per year over that 10-year period? And whilst today the yield on equities might be lower, if that scenario were to play out, then you’d end up with more income return from equities over that period. So, you know, I don’t think it’s an either / or discussion. I think we want to have a balance of the two, but I think in this inflationary environment, equities are going to be key.
(SS):
And perhaps finally, you could talk us through about some of the changes that you’ve made in the fund recently. I think you’ve sold British American Tobacco, for example, and you’ve bought Coca-Cola. Perhaps you could talk us through the reasoning behind that and maybe one or two other changes?
(MP):
[09:27] Yes, of course. So, we’ve made a number of changes this year, 4 out of our 35 companies we’ve sold, and we’ve replaced those with four new companies. And we have a ‘one in, one out’ approach. So, if we find something we want to buy, we have to sell something, and if we find something in the portfolio that we’re worried about, then if we want to sell it, we’ve got to bring something else in to replace it. So, the portfolio always has 35 names.
And so, in July, we started to think that the valuations of a number of companies had probably run a bit far. So, there are really two areas where we sold positions. One was two of our tobacco names, so British American Tobacco and Imperial Brands. And these are companies that have got well-documented headwinds in terms of regulation and growth, and their investments into next generation products. But they were very much, from a factor perspective, very appealing to investors at the beginning of this year, as we saw that big rotation out of kind of disruptive tech and into deeper value, – these companies have historically traded on very low multiples. So, by the middle of the summer, we’d had quite a strong rerating in these companies, and we decided ultimately, we wanted to bank that relative outperformance, and rotated elsewhere.
The other area was on defence. So, we had two defence companies. We had British … BAE systems, I should say, and Raytheon Tech[nologies], and again, really strong relative performance over the first half of the year. Clearly, the Russian invasion of Ukraine has completely changed the outlook for defence spending by the West, and particularly in Europe. And, as a consequence, these companies had, again, rerated.
So, essentially what we were doing in the summer was, we sold four of our five best performing companies relative this year. Not because we thought the outlook for them was, you know, dramatically changed, but just we thought the valuation risk now was more significant.
And so, we rotated the companies into four new companies. As I say, we bought Coca-Cola, we bought a company called Mondelēz [International, Inc.]. These are two food and beverage, fast moving consumer goods companies. And then we also bought two industrial companies. We bought Atlas Copco and a company called Emerson Electric [Co.]. And, you know, on the consumer staple side, I think you know, we, as I mentioned earlier, we’ve seen some really strong pricing power coming through from these companies. Coca-Cola grew its revenues 20% in the second quarter; Mondelēz again, was talking about relatively little price elasticity. So, ie. if you put your prices up, it wasn’t really affecting the volumes that they were getting from the West, and they were actually seeing very strong consumer confidence coming out of emerging markets. So, we liked that profile for this difficult environment that we’re in at the moment.
And then I think the industrial names; these were names that are clearly more cyclical, but crucially from our point of view, they do meet our requirement of consistently generating high return on capital. And a big part of that is the fact they have high levels of recurring revenues. So, servicing the equipment that they sell, can make up 20- 30% of these companies’ revenues, which makes them a little more stable than other industrial names.
So yeah, the overall effect of that was therefore, to sort of increase our North American exposure a little bit, reduce our UK exposure a little bit. But from a sector point of view, it was fairly neutral. It was two consumer staples for two consumer staples. The defence names sit in the industrial space, and we replaced them with two more industrials.
(SS):
Well, that’s a really good update. Thank you very much indeed.
(MP):
Thanks Sam.
(SS):
And if you’d like to find out more about the Guinness Global Equity Income fund, please go to FundCalibre.com. And don’t forget to subscribe to the ‘Investing on the Go’ podcast.
Outro
Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening, Elite Ratings are based on FundCalibre’s research methodology, and are the opinion of FundCalibre’s team only.
