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Bearbull Income Portfolio: The great dividend re-set

UK company dividends are recovering, but may never be the same
Bearbull Income Portfolio: The great dividend re-set

There are two really good things about using natural gas as an energy source. First, it has a higher energy content than its fossil-fuel alternatives – maybe 25 per cent more than oil and twice as much as coal. Second, and perhaps more important, it emits less CO2 for every unit of energy produced – about a quarter less than oil, but almost 50 per cent less than coal.

So natural gas is the fuel of the future, right? Obviously not. But it may be the fuel of the energy transition and especially in the US, which uses coal for about 40 per cent of its electricity generation. That’s still much more than the share generated from gas-fired plants. But gas’s share – currently 28 per cent – is rising and should continue to do so.

In which case – and this is where self-interest comes in – holding shares in Williams Companies (US:WMB) has to be sensible. Tulsa-based Williams runs a big chunk of the US’s gas pipelines – about 20,000 miles-worth, which shift about a third of the nation’s gas supplies. Chiefly, this includes its Transco pipeline, 10,000 miles of pipes that take gas from the Gulf of Mexico to upstate New York.

Perhaps crucially for Williams, the price of the gas it shifts isn’t that important. What matters is the volume and the trend is upwards. In 2020, on average each day Williams’ pipelines moved 4.3bn cubic feet of gas, 19 per cent more than two years earlier. After a harsh winter in 2021, volumes will be up again this year. That is a big factor behind the decision by Williams’ bosses to raise their guidance for 2021’s cash operating profit (ebitda) to a midpoint of $5.5bn (£4.1bn), 8 per cent higher than 2020.

Simultaneously, the group’s debt leverage is dropping. At the end of September it was 4.0 times Ebitda compared with management’s target of 4.2 times by the year-end. That ratio still looks high, although Williams’ utility-style predictability should be able to cope with it. Its bosses seem to think so – in response to pleasantly-high cash generation they have just announced a one-off $1.5bn share buyback programme.

Naturally, there are caveats. Chief of these is that natural gas is not necessarily that ‘clean’ a fossil fuel since the methane it emits is about 20 times as potent a greenhouse gas as CO2. Meanwhile, if technology came up with largescale processes to convert coal to gas or to sequester carbon then much of gas’s advantage could be lost.

These risks don’t readily undermine the logic behind holding shares in Williams, as the Bearbull Income Portfolio has done since mid-2018. Granted, the return to date has fallen short of expectations. At $28.24, the share price is 5 per cent below my buying price, although by the year-end that deficit will have been cancelled out by dividends received, which currently produce a 4.9 per cent yield after adjusting for unavoidable US withholding tax. That’s an inviting income return for a stock that should come with growth prospects. I might even top up the income portfolio’s below-par holding.

 

On the Record

Meanwhile, here’s a first: ‘inexorable’ in a company’s results announcement. In over 40 years in the investment game, I can’t remember seeing it before. “Our inexorable move to a more technologically-agile and diversified business” continues, says Leslie Hill, the newish boss at currency manager Record (REC) in its results for the first half of 2021-22.

It’s a brave word because in a company’s life cycle nothing is inexorable except, perhaps, decline. As to diversification, Record still looks much like the business that got its stock market listing 14 years ago. Basically it manages currency exposure for institutional clients. Some management is passive, with the aim of eliminating movements against a base currency either way; some dynamic, which usually aims to keep the gains but sidestep the losses. Passive hedging is the bread-and-butter stuff where Record’s income is comparatively predictable even if margins are tight and growth is dull. Dynamic hedging tends to be the opposite.

Onto this, Record is diversifying geographically and with new products. During the summer it launched a dynamic hedging service in Germany and its EM Sustainable Finance Fund, which holds emerging-market and frontier-market debt and aims to spice up returns via active plays in emerging-market currencies.

More such moves are promised, which should be good. Not only should they raise the notional amount of funds that Record manages, which hasn’t changed much over the years, but also bring in business at better profit margins. Sure, diversification always brings risks and Record operates in competitive markets with a comparatively small number of clients where mandates can easily disappear. But those are facts of life that Record’s experienced bosses have lived with for years.

Arguably, the greater concern is that movements in Record’s share price are often a geared play on sterling’s exchange rate with the US dollar. When sterling rises, Record’s price follows, as it does when sterling falls. No surprise, therefore, that since the summer, and as sterling dropped 6 per cent from a three-year high against the dollar, Record’s share price (now 83p) dropped 19 per cent from its August 10-year high of 102p. Sterling now looks oversold, but if its long-term trend is decline against the dollar, Record’s share price is likely to face headwinds not of the company’s making.

It’s a factor I can live with for the time being, especially as there is a higher priority for the income fund – how to invest the £18,000 due imminently from the takeover of Stock Spirits.

 

'Won't come round again'

Turning that investment into cash won’t affect the fund’s dividend income for 2021, which is now settled. Compared with 2020’s depressed distribution, 2021 will look great, 23 per cent higher at almost £13,000. A comparison with 2019 might be more realistic and 2021’s figure will still be 22 per cent lower than 2019’s. That said, the comparison with 2019 is especially demanding since listed companies were overdistributing immediately before the Covid pandemic struck. Thus 2019 brought to a close a wonderful period when the Bearbull portfolio’s distributions compounded at 7.2 per cent a year in the 10 years starting in 2009.

Sustained growth like that is unlikely to come around again any time soon. But this also raises the bigger question: can equities, and especially those of London-listed companies, continue raising dividends faster than inflation? Arguably, in the UK there has been a trade-off between rising dividends and stagnant capital values. In that context, two details in the income portfolio table are telling – the contrast between the performance of the FTSE All-Share index since the Bearbull portfolio was launched in late 1998 (up 68 per cent) with the rise in inflation (up 90 per cent). In other words, the capital value of UK shares, on average, have declined substantially in real terms.

There could be a causal link; the implication being company bosses rewarded shareholders rather than invest capital in the companies they ran. That might have been self-serving, but not necessarily so, nor necessarily stupid. It would depend where higher future returns were likely to be on offer, within UK plc or elsewhere. However, it does not say much for the perception of UK companies’ prospects.

This sad state of affairs may be a function of the declining productivity of UK plc. Alternatively, it might reflect the absence of technology stocks on the London market. Whatever the cause, the performance of UK shares becomes more sobering – numbing even – when compared with US equities. In contrast to the table’s data for the All-Share index and UK inflation, the corresponding figures for the US are inflation of 69 per cent since September 1998 and a 358 per cent gain in the S&P 500 index.

True, the difference would be narrowed in a comparison of the total return of the All-Share and S&P 500 indices. Then there is the consoling notion that the UK economy and its listed companies are not that bad and that the power of mean reversion will foster a period much like the 20 years from the mid-1970s when UK share returns powered ahead of the US. Maybe, but don’t bank on it.

 

BEARBULL INCOME PORTFOLIO         
Shares bought Date dealt Price (p)  Cost (£) Price now (p) Value (£) Change (%)v All-Share (%)IndustryWeight (%)
1,665GlaxoSmithKlineFeb-001,28221,4821,52125,325 19-13Pharmaceuticals9.4
13,150NatWest 9% PrefsNov-12121 16,016169 22,184 394Fixed interest8.2
14,000Real Estate Credit InvJan-13110 15,432154 21,490 4011Speciality finance8.0
26,800RecordSep-1436.5 14,69882.0 21,976 125104Financials8.2
29,250Air PartnerSep-1484 24,71580 23,459 -4-10Travel & leisure8.7
4,550VesuviusAug-15392 17,827416 18,937 6-3Industrials7.0
12,806Randall & QuilterMar-1815119,354175 22,411 1615Aim:insurance8.3
850The Williams Co'sAug-18$29.8720,136$28.2417,636 -5-3Utilities6.6
8,000Henry BootJul-1924419,60226120,880 710Real Estate Inv't7.8
575Anglo AmericanAug-201,94411,2572,70915,577 3919Basic materials5.8
222Berkeley GroupAug-204,65710,3964,2459,424 -9-22Housebuilder3.5
4,775Stock SpiritsAug-2023111,08637718,002 6439Drinks 6.7
8,000Carr's GroupAug-1613811,08014211,360 3-12Foods4.2
3,650Moneysupermarket.comAug-2030211,0962047,446 -32-42Technology2.8
8,500Primary Health Prop'sNov-2115313,08615112,835 -13Real Estate Inv't4.8
     Total268,940     
     Cash4,261     
     Interest accrued    
     Ex-divs316    
Starting capital (Sept 1998)  £ 100,000Total273,524 174   
FTSE All-Share index  2,384  4,015 68   
Retail Price Index  164 31290   
Income distributed:  £ 223,865