Join our community of smart investors

The flexible approach

Dividend cuts have forced changes to the Bearbull income portfolio

The flexible approach

JM Keynes reputedly said: “When the facts change, I change my opinion. What do you do, sir?” although the quote is also attributed to an almost-equally-famous economist, Paul Samuelson. No matter. The point is that changing your mind is okay. Rather than becoming set in the concrete of dogma, altering your views – and, therefore, your actions – when circumstances change is good. Flexibility beats rigidity.

It is in that spirit that this week sees three changes to the Bearbull Income Portfolio. They have all been previously signposted but have been expedited by the need to maintain the portfolio’s receipts of dividend income. Without these moves – and possibly others to follow – the income portfolio’s own distribution risked being lower year on year in the first half of 2018.

The catalyst was results for 2017 from satellite communications provider Inmarsat (ISAT). Would that Inmarsat’s bosses were as good at generating growth and cash profits as they are at spinning a line, then they wouldn’t have had to cut the company’s dividend. True, there was a grim predictability about the cut. After all, late last year, when Inmarsat’s share price had dropped from 2017’s high of 850p to about 450p, the dividend yield – based on the previous 12 months’ payouts – was 9.4 per cent. A yield of that level has to be viewed sceptically.

Now the directors propose cutting the annual payout to 20¢ (about 14p), although they manage to make that sound like they’re doing shareholders a favour. The “increasingly clear opportunity that exists for Inmarsat in the fast-growing IFC segment” (ie, providing high speed broadband to in-flight air liners) is their chief reason to slash the payout. Not that this factor is exactly new. Inmarsat has been spending heavily to deliver satellite-sourced broadband for some years; in the past five years, capital spending has averaged $440m a year, approaching twice the level of depreciation. It will rise a bit further in the coming three years before moderating “meaningfully” after 2020, according to the directors. The implication is that by then IFC – in-flight connectivity – will be a wonderful cash cow. Yet that prospect hardly tallies with the directors’ forecast of pedestrian revenue growth of only 5 or 6 per cent in the next five years. Small wonder shareholders were underwhelmed and, last seen, the shares were trading below £4, although I sold the income portfolio’s holding at 422p on Monday morning.

If I were running a recovery portfolio I might stick with Inmarsat or would sniff around its stock at its current price if I didn’t own it. But I’m not. It’s income I need and with the yield down to about 3.5 per cent, Inmarsat won’t provide enough to compensate for the uncertainty in its plans.

Besides, income is falling short elsewhere. For a while we have known that student-accommodation provider Empiric Student Property (ESP), another of the income portfolio’s holdings, is trimming its dividend. I could live with that, but the outlook for the portfolio worsened when speciality chemicals supplier Elementis (ELM) announced a dividend cut with its 2017 results. Last year Elementis made the $360m acquisition of SummitReheis, which supplies the active ingredients for deodorants. That was a biggish deal and took the group into net debt. Now its bosses no longer want to pay special dividends while the group’s net debt ($291m at the last count) is more than its gross cash profits or ‘ebitda’ ($156m in 2017). For as good a cash generator as Elementis is that might be ultra cautious and the special payouts might resume soon enough. Still, it adds to the income portfolio’s challenges, especially as I struggle to justify holding Elementis's shares at all when the yield on 2017’s base dividend runs at just 2.1 per cent.

The solution – or, at least, the first part – is to sell the portfolio’s holdings in both Inmarsat and gold miner Pan African Resources (PAF) and use the cash generated to buy a holding in insurance-industry player Randall & Quilter (RQIH) – see Bearbull, 19 January 2018, for a quick appraisal.

Last week I warned that the portfolio’s holding in Pan African had to go. Maybe I wasn’t expecting to sell it so soon, but clubbing together the proceeds from selling both Inmarsat and Pan African allowed me to buy a proper holding in R&Q. Be warned, however, the shares are illiquid. I had to sneak back into the market three times to build the portfolio’s holding of 12,250. Sure, selling Inmarsat so soon after its results meant I lost the right to the final dividend. But that will be more than compensated by receiving R&Q’s final dividend for 2017, assuming it is paid in mid-June (as it was last year) and at the same rate (5.2p, although it will probably be raised). Meanwhile, Pan African does not pay a dividend in the first half of the calendar year anyway.

The net result is that the income portfolio should pick up an extra £400 or so in the first half. That’s hardly transformative, but it’s better than a poke in the eye and simultaneously I swap shares in two strugglers for one in whom the force seems strong. Granted, that may be chiefly because R&Q is on an acquisition binge thus pushing extra capacity through its largely fixed-cost base, from which it runs closed books of non-life insurance, does niche underwriting and acts as managing agent for other underwriters. Still, it will do for now.