Citywire AA-rated income manager James Henderson is holding steady with his significant overweight in industrials, arguing that despite the sector’s recent strong performance, underlying dividend growth can continue to power these stocks.
The Henderson UK Equity Income manager is allocating around 39% of the portfolio to industrial names.
Although the allocation has helped drive performance, and a sector re-rating after a strong run could suggest it is time to lock in profits, he says underlying cash generation and increased issuance of special dividends paint a different story.
‘We like industrials and it is easy to say, “When should we take profits?”. You just need to look at cash and how far debt has fallen. Now these companies have surplus cash and are returning cash in special dividends or they are making earnings-enhancing acquisitions. Some of these acquisitions are definitely adding value,’ he said.
He cites DS Smith’s acquisition of SCA Packaging as an example of this as it enabled the company to expand its geographic presence.
Increase in special dividends
Driven by corporate debt levels falling and improved cash generation, Henderson expects to see more companies paying out special dividends looking ahead.
He is also keen to remind investors ‘don’t worry about headline yield, it is about dividend growth’, adding that higher yields are by no means an indicator of value.
Speaking ahead of the oil price rise that followed discussions of an air strike on Syria, Henderson highlighted resources stocks, particularly oil exploration companies, albeit low yielding, as an area on the radar.
‘Some of the resource stocks, particularly oil exploration companies, have fallen to low valuations. Valuations are getting really compelling in places at the moment and you can buy at discounts to most forecasts of book value. I think that is intriguing me,’ he said.
As a result, he recently bought into oil and gas exploration and production company Circle Oil.
Although financials represent Henderson’s second largest sector weighting at around 27%, the fund manager remains lukewarm on the prospects for UK banks and holds the majority of the allocation in insurers.
‘It is difficult to know what the earnings and dividends are going to be. I feel it is simpler to invest in more visible things in the market. If you think about what is happening in closed life books you can see how cash has come off and debt has been paid down, which gives you greater clarity as a result,’ he said.
Closed life book market
In the closed life book market, Henderson is holding Phoenix and Chesnara. Non-life insurer picks include Hiscox and Amlin, while life insurers Prudential, Standard Life, L&G and Aviva also sit in the portfolio.
He notes that life insurers could stand to benefit and improve their income line if yields rise due to the amount these companies are currently allocating to short-dated gilts.
Buoyed by changes to ISA rules, Henderson is bullish on AIM stocks, which represent 7-8% of the portfolio.
He highlights Scapa, which manufactures adhesive components, as a top pick in this area and expects to see further dividend growth next year.
He also participated in the Conviviality AIM IPO, which is behind the Bargain Booze brand.
Over the three years to the end of July, the Henderson UK Equity Income fund posted a 74.8% return versus a 50.8% rise by the FTSE 350 Higher Yield index, according to Lipper.
The fund has a yield of around 3.5%, which Henderson said has been boosted by the likes of Hiscox’s strong double digit distribution growth.