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BP's shocker and the search for dependable dividends

David Smith of Henderson High Income expresses concern for BP's dividend but says pubs and retailers can offer a safe haven.

BP's shocker and the search for dependable dividends

In a video interview recorded on Tuesday after BP revealed record annual losses, David Smith of Henderson High Income (HHI ) investment trust assesses the pressures on the oil giant's dividend.

Despite low global economic growth, Smith talks about how he can find pockets of growth in the UK and identify individual companies that can grow their earnings and dividends to shareholders.

Income investing is not just about finding the highest yielding stocks. Smith explains how he constructs a portfolio that can generate a 5% yield and some capital growth.

Can't watch now? Read the transcript

Gavin Lumsden: Hello, with me today is David Smith, manager of the Henderson High Income investment trust. David, thanks very much for coming in.

David Smith: Pleasure.

GL: Can we start with a conversation about BP which has just shocked the market today with news of its biggest ever annual loss and the shares have fallen very heavily. Do you hold the shares?

DS: I do. I am underweight relative to the benchmark.

GL: So how much of the fund have you actually got in BP?

DS: I’ve got 2% in BP. Clearly the results were disappointing. They missed analysts’ expectations both in terms of the upstream business and in terms of the downstream business and I think the one key concern for investors is the cash flow generation. They generated $4.5 billion of organic free cash flow but that’s set against $5.5 billion of cap ex in the quarter and a $1.8 billion dividend so clearly …

GL: So not enough money coming in to pay for all the capital expenditure and of course the crucial dividend?

DS: Exactly and that’s all down to where the oil price has gone to. Now given the strong balance sheet the company has they can probably afford that position at the moment. But if we stay at $30 [a barrel] for a protracted period then clearly the dividend comes under increasing pressure really.

GL: And the shares have fallen a lot and they’re yielding 8% so that’s indicating a fair degree of scepticism by the market around the dividend.

DS: It is yes. And time will tell. Again it’s kind of predicated on where the oil price goes over the medium term. Again in the shorter term, certainly for this year, I’m pretty comfortable they can pay that dividend.

GL: Now you haven’t got a big chunk of the fund only about 2% as you said in BP so you were kind of cautious about prospects for the big oil companies anyway presumably?

DS: Yes they are very big companies in the UK and they represent quite a large proportion of the market so to have quite a large portion of your fund in that kind of ties up a lot of capital that can be deployed elsewhere, where I see better opportunities longer term.

GL: Dividends seem to be under pressure on at the moment with the global economy slowing down. Where are you looking to find sustainable and good dividends?

DS: Well certainly it feels like it’s much more on a stock by stock basis. I look around the market, you know, there are pockets of growth out there, I think the UK consumer is well set, low interest rates, low inflation, wage growth is coming through for the first time in a number of years. So any companies that are exposed to consumer discretionary spending, you know I think the consumer is…

GL: Which companies are we talking about there then?

DS: Well you know the pub companies. I own Greene King, Marstons for example, some of the retailers, I own some Marks & Spencer.

OK recent trading has been difficult because of the weather but I think hopefully over the medium term margins can improve. When you compare Marks & Spencer’s margins to Next there’s almost a self-help opportunity there, which kind of brings me on to my second area of opportunity is those companies with self help. I spoke about Greene King just then. They’ve just done a deal to buy Spirit Pub Company. I think given the opportunity to drive synergies out of that deal, to drive better profits within the pubs of the company they just purchased that can help drive earnings growth irrespective of whether the consumer is as robust as maybe we think.

GL: Henderson High Income is one of the highest yielding equity income trusts, it’s got a yield of about 5%. So to generate that you’re not just going out and buying high yields. What exactly are you doing?

DS: Well, as you said, it’s not about just finding the highest yielding shares in the market because certainly the dividend yield in isolation can be a misleading guide to value really. It’s more important to look at the sustainability of that dividend and whether the company can grow that dividend longer term.

So what we do is, yes we own some companies that have a high yield but we have to make they can pay it and hopefully grow it into the longer term. And we combine that with some of the companies that may have a lower yield but offer much more in terms of dividend growth, you know the ITVs  of this world which have committed to grow the dividend by 20% each year over the next few years really.

GL: So there are lots of reasons to be positive then, because there’s a lot of gloom around at the moment? Do you think income investors, despite low interest rates, low inflation and turbulent stock markets, that there are these good companies around?

DS: Yes I think, OK we are in a low economic growth environment. But I look around the market I still see an awful lot of opportunities, yes they’re few and far between, there  aren’t loads of them about but I can still find opportunities. And it’s about finding those companies that like I said have got something about them, that can grow their earnings because growth will be hard to come by.

GL: David, thanks very much.

DS: Thank you.

6 comments so far. Why not have your say?


Feb 04, 2016 at 18:33

"I still see an awful lot of opportunities, yes they’re few and far between, there aren’t loads of them about "

Um. So which is it? An awful lot, or few and far between?!

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Dr John

Feb 05, 2016 at 01:02

A classic fence-sitting, "I don't know, & if I do I'm not telling you" piece of rubbish financial journalism.

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r rodney

Feb 05, 2016 at 10:53

an awful lot or few etc and "fence sitting" (simplistic or what !!)

what sort of "rubbish" comments are these above. General dismissive and negative comments I say. It amazes me that you get people writing such simplistic negative comments....what a waste of time and space. Its as if you have no respect for the interview and in your dismissive comments (obviously casual comments) you feel there is nothing worthy of constructive comment.

I listened to the narrative and I come to the conclusion that Gavin is an excellent journalist and commentator...gets down to the nitty gritty commonsense questions which I might ask if I had the chance to be there. I like listening to this guy question the fund managers. I noted also that the trust has a good record over 10 yrs so that is a track record to highlight and have respect for. It offers 5.2% yield so yes that's good information and conducive to holding in a portfolio. So, in commenting on the interview, I would say this is a good opportunity to make a judgement on the personal skills and demeanour of the trust manager and listen to his methodology...which seems to me very satisfactory.

Now when it comes to decisions on specific company choices I wouldn't expect him to go into great detail. Course he's not going to tell you and unless you started investing this week then you are off piste. First off you get the top 10 companies from the annual accts so that's a start. Are you telling us that if he spelled out what companies he had bought in the last 6 months that you would then go out and buy them. Ha ha. I think not.

Read Citywire more often and you will find enough market information on dividend opportunity companies to keep you busy trying to distil your decision making all day long.

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William Phillips

Feb 05, 2016 at 12:47

"I noted also that the trust has a good record over 10 yrs so that is a track record to highlight and have respect for. It offers 5.2% yield"

You what? HHI's dividend has been shrinking in real terms for 25 years, and its net asset value per share is no better than a closet tracker of the All-Share.

Gavin Lumsden could and should have torn its record to shreds. The 'high yield at all costs' strategy is a crock.

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r rodney

Feb 05, 2016 at 13:14

fair enough I'd say to that...except I just havn't got the time to go through it all myself. Those are the figures that were quoted on the screen in the vid but I take your point about the NAV. I didn't go off to check anything myself. So what's your recommendation for a Trust.

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William Phillips

Feb 08, 2016 at 13:31

r rodney- For income, I would go for a trust with a consistently above-market yield but a history of raising the dividend in real purchasing power terms, most of the time.

If it can bring that off, it is prima facie evidence that the asset base generating the revenue is sound. That quality should be reflected in NAVs- though these are based on the market prices of portfolio holdings, which fluctuate more than the divs the holdings pay to the trust.

Examples of ITs which do not bust a gut for immediate payout but keep it moving in most years except those of a severe squeeze (i.e. the late 2000s) are City of London, Temple Bar, Edinburgh or Perpetual Income and Growth. Murray International has done the same with overseas stocks.

They do not yield as much to begin with as Henderson or Merchants, but slow and steady wins the race, if you want an income machine to wind up and forget about while it does the business.

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