Citywire AA-rated JP Morgan Higher Income manager Ben Stapley believes there are reasons to be cautious about equity valuations but that select cash-rich corporates will keep aggregate dividends high.
In particular, he is mining opportunities in high street retail that are either winning or succeeding against the flow of punters to online, and he believes some resource stocks have been derated too far.
‘The question is how much fuel there is left in the tank – whether the FTSE can keep on going through 2014 or whether we are now running on fumes,’ said Stapley.
‘The third quarter earnings season was, on balance, disappointing. Earning were broadly in line but expectations had been so downgraded over the period that we can call that a disappointment.
‘[Earnings] numbers are down something like 9.7% over the last six months while markets have gone sideways, so UK equity is now looking a fair bit more expensive.’
Sense of caution
This more general sense of cautiousness did not obscure the strength of selected cash-rich businesses however, in particular those targeting shareholder returns rather than capital spending.
Stapley said even in buoyant markets he was still identifying material misvaluations and turnaround stories.
Possibly the standout example of this theme is Halfords. ‘Halfords is really interesting – it’s a great turnaround stock. It has been increasing its servicing revenue and announced a 7% sales rise surprise in the third quarter, it has benefited from the tail-wind of interest in cycling following the Olympics.’
The company’s revenue from bike sales rose 14.2% over the first half, compensating for a 2.1% slide in sales at its autocentres, while profits at the company rose 5.2%.
Halfords shares have already appreciated rapidly however, rising 38.95% over 12 months versus 16.14% on the FTSE All Share.
‘In the shift to online, 90% of their online sales are collected in-store so they are not hollowing out their shop sales, like some businesses. Having rerated it now only yields 3%, so it is almost getting a bit too expensive.’
While that might illustrate the challenges of investing in value in 2013, capital return opportunities were more broadly spread and more diverse.
‘We have found opportunities in services, in media, in energy. It’s interesting because companies like to pay progressive dividends, and they hate to cut dividends. So what we have seen is a lot of one-off and special payments, as well as share buybacks.
ITV has recently paid a big [one-off] dividend and more generally holds lots of cash, as well as growing its non-TV revenues.
‘We have seen a similar phenomenon at BP, where everyone has been focused for several years on the liabilities of the Macondo disaster. But that is growing less important. Third quarter [profits] were well ahead of expectations and guided very clearly that it will return around $10 billion (£8.33 billion) to shareholders over the next two years.’JPM’s income picks
Even though it does not pay a dividend, by 2015 consensus is expecting a 5% yield so as income investors we want to own it. We like high quality and proven quality, and it is rapidly improving both its capital and its loan losses. It is also the most exposed to the UK [of the big four banks], which we like.
It’s the poster-child for share buybacks – it has spent something like £500 million on buying its own shares in recent years and over that period has offered something like a 500% total return. [It’s not cheap at £54] but Next still has a lot of valuation potential.
It is focusing on lower cost, higher-grade metals rather than investing a lot of capital in exploration and development, which is generally a big drain [on capital] in the mining sector. That means the dividend cover is increasing and the company is not so dependent on the market price of any specific metal. It currently yields around 4%.