Momentum and recovery

True, momentum – at least, of the upwards variety – is not something you expect to find much of in an income portfolio. After all, ‘high yield’ is associated with low growth and that’s hardly consistent with the ebullience needed to foster upwards momentum.

Then again, high yield can also be linked to recovery, an ingredient that certainly contributes to momentum. In that context, consider the companies in the table. Shares in all of them – to an extent – combine a high dividend yield with price momentum and recovery potential at the underlying company. 

This is an exercise I used to do some years ago but, for no particular reason, stopped. The basic idea is simplicity itself. It is to contrast long-term price performance – here, five years – with the short term (six months). The stronger the contrast between a lousy long term and an improving short term, the better the chances that something good and sustainable is happening at the company concerned. And the depth of the current share price below its long-term historical level is a crude indicator of how much recovery potential remains.

The choice of six-month and five-year time spans with which to make the contrast is arbitrary. Yet you don’t want either to be too long or too short. Too long in the case of the longer period – say, 10 years – and the danger is that companies change so much you are no longer comparing like with like. Too long in the case of the shorter period, say one year, and the risk is that too much recovery will be priced in; too short a time and it will be more difficult to spot a trend.

Of the companies in the table, the one showing the strongest momentum is – ironically – oil-industry engineer Petrofac (PFC); ironic because I sold the income fund’s holding last May. Given the risks, mostly connected to an investigation by the UK’s Serious Fraud Office into its affairs (see Bearbull, 19 May and 2 June 2017), I will stay clear of Petrofac.

The two that catch my eye are consumer-credit lender International Personal Finance (IPF) and brewer and pubs operator Greene King (GNK). IPF has a slew of problems in its biggest market, Poland, which have battered its share price. Even at its current 252p, the price is still 62 per cent below its all-time peak. The outlook in Poland remains murky. First, a long-running dispute with Poland’s tax authorities drags on, although that only seems to involve £20m. Second, and more serious, Poland’s government has proposed a further cap to the charges that lenders can slap onto consumer loans. If this were enacted – and, 15 months on, it remains uncertain – that would further erode profits from the country that probably contributes about two-thirds of the group total.

The trend towards more regulation is likely to be a constant in IPF’s developing markets, but so, too, should be rising demand from aspiring consumers. Assuming growth comes through from southern Europe and Mexico, then earnings in 2018 may recover to 2016’s level (31p per share or thereabouts); enough to ensure the 12p dividend is maintained. Yet that may not convince me to buy the shares since IPF’s cash flow may be deficient. It hasn’t generated positive free cash flow since 2014 and in the past five years has racked up a £42m net cash outflow before paying £127m in dividends. True, that cash outflow may have been primarily the result of growth – extra working capital sucked £272m out the group during that period – but it requires further inquiry.

Meanwhile, shares in Greene King – much like other pubs operators – have been rising not so much because trading is strong but because it has beaten dull expectations. Helped by cost-cutting, Greene King’s earnings for the year just about to end should be back to around 2015-16’s 64p. That will be plenty to maintain last year’s 33p dividend, which should – for the second year running – be covered by free cash flow. In other words, the 5.9 per cent yield (see table) should be secure and there may even be a little scope for the share price to rise further, not that I want to be betting too heavily on the resilience of the UK consumer.

■ It is axiomatic that profits warnings come in threes. In which case, there should be more bad news to come from air-travel broker Air Partner (AIR) following the revelation of a £3.3m glitch in its accounts, more recently updated to £4m (see Bearbull, 13 April 2018). Despite the power of this axiom, I have topped up the Bearbull Income Portfolio’s holding in Air Partner by 10,000 shares at virtually 100p each. The prompt was an additional update from Air Partner’s bosses. First, this was fairly definitive that the trouble has been both quantified and contained; second, it promised a 3.8p final dividend for 2017-18, which will be confirmed when delayed results for 2017-18 are finally announced at the end of May. The prospect of picking up a 3.8 per cent yield on the final payout alone was appealing, given the cash sitting idly in the income fund following the sale of its holding in Boeing (US:BA). And if Air Partner’s £4m bad debt is, indeed, a one-off relic, then there should be 50p of upside in the share price.