Aiming for income

It is the low-probability, high-risk events that can kill, and that’s precisely because they are so difficult to forecast; events such as the spread of the Sars-CoV-2 virus or the spread of Russian Armata tanks into Ukraine.

It’s only after the event happens that the talking heads line up to tell us that, actually, it was entirely predictable; that we should have known all along. Everyone knows major pandemics come around every 10 to 20 years, they tell us – H2N2 influenza in 1957-59, followed by the H3N2 variant in 1968-70, then H1N1 in 2009. So it was obvious more viral nastiness was on its way somewhere around 2020. Similarly, by 2022 Europe, for so many centuries the global cockpit, had not seen a major war for over 75 years, unless you count the break-up of Yugoslavia in the 1990s. So it was obvious Vladimir Putin’s threats were a well-worked strategy that would culminate in the shattering of peace and not the ramblings of a bored mind driven by a monumental inferiority complex whose judgment was corrupted by 20 years spent in an echo chamber of sycophants.

But even on 23 February, the day before the tanks trundled in, for every talking head who said there would be a full-scale invasion, the media could find another who said “No, it’s just a bluff to snaffle a bit more of eastern Ukraine”.

Yet now that this particular risk has become real, who is prepared to step into the uncertainty on the logic – or is it just the hope? – that shares in the worst-effected listed companies are now oversold.

One factor prompting this thought is the knowledge that equity markets have always bounced; or at least they have in the past 50 years. Thus it is extremely easy to tip that observation into the certainty that they always will. Besides, in the most recent major instances, remember how quickly they bounced in 2009 and in 2020? Almost before the trouble had thickened, equities were up again, helped by prodigious amounts of public money. Surely it will be the same in 2022, as Ukraine’s tragedy turns into a bloody stalemate and affluent westerners prioritise their cost of living over the cost of life elsewhere.

The notion that the worst-hit companies may be oversold also emerges from working up the idea of an income portfolio comprising only stocks from the Aim. As Table 2 shows, this is not a silly notion. Fish in Aim’s pool and an investor is working with 184 out of the 764 components of the FTSE Aim index that are forecast to pay a dividend in their current year. And virtually the fattest yield on offer from companies that seemed to stand a decent chance of paying the dividend forecast by City analysts just happens to come from a company whose fortunes are tied closely – albeit tangentially – to the Ukraine war.

Steppe Cement (STCM) is a major cement producer in Kazakhstan, which will be announcing decent results for 2021 in May, but whose tone will be shaped by the state of the Ukrainian war. The year’s revenue was 16 per cent higher, albeit in the local currency, thanks to a 2.6 per cent uplift in volumes and a 13 per cent rise in prices. For 2020, the company paid a 3.5p dividend and a 5.1p payout looked likely for 2021, 2.5p of which has already been distributed. True, that level of dividend would have absorbed almost all the group’s net profit, but Steppe is encumbered with next-to-no net debt. So, before the invasion of Ukraine, with the share price at 40p, Steppe’s shares offered a 12.8 per cent yield. Now, with the price down to 25p, the prospective yield is 20 per cent.

It’s risky enough investing in Kazakhstan anyway. After all, in 2020 it ranked 99th out of 179 in the world in the Corruption Perceptions Index, an assessment of graft and theft in a country’s state machinery which is produced annually by Transparency International, a think tank. But it might be worse – Russia ranked 129th and even Ukraine, a beacon of democracy only in the western media’s present narrative, was 117th.

A yield of the scale now offered by Steppe Cement says the dividend won’t be paid. Since Kazakhstan now faces risks that could be existential, the yield conveys a plausible message. Effectively, Kazakhstan is Russia’s vassal state, which – even if it can extricate itself from the opprobrium heaped upon the Putin state – still has the grave difficulty of being landlocked in central Asia with most land routes in and out of the country via Russia. For Steppe Cement, which was formed from cement works owned by the Soviet state, it could hardly get worse.

In which case, only the bravest investor would put its shares into an Aim income portfolio. Arguably, it’s brave to imagine that Aim could provide an income portfolio in the first place. The basic data aren’t too encouraging, as Table 3 shows. The dividend payers tend to be the bigger companies by market capitalisation and, implicitly, those will also be the better established, which is reassuring. But, taking the simple average, forecast dividends for the current year are not covered by earnings. Granted, that average is suspect because a big dip in earnings can be just temporary or a result of odd accounting rules and the median payout ratio is 46 per cent, which reassures somewhat. The payout ratio for the 16 in the table is 75 per cent – just about acceptable.

Even so, as we might expect, the Aim index is not a natural place to hunt for income plays. Hence the inclusion of some stocks whose dividend yield is too low for them to be conventional candidates. But let’s be clear, the 16 shown in Table 3 don’t comprise a recommended portfolio anyway. Rather, they form a collection that says, “this is what an Aim income fund might look like”. And, quite possibly, an investor could spend months of research and still emerge with a portfolio looking remarkably like the one in Table 3. After all, there are all sorts there – the familiar and the little known; the solidly predictable and the cyclical; the old technology and the new.

Most contentious – apart from Steppe Cement – would be the inclusion of Central Asia Metals (CAML), a copper miner in Kazakhstan and a miner for lead and zinc in the micro state of North Macedonia. Then there is Supreme (SUP), an odd but interesting collection of fast-moving consumer goods, which is led by its 88vape vaping liquid and collection of sports nutrition bars and drinks. The idea is that their growth potential is underpinned by the cash-generating ability of Supreme’s distribution of consumer batteries, a niche of which Supreme claims 20 per cent of the UK market. Not that investors seem completely convinced. Following the flotation 13 months ago, the share price peaked at 244p in December but has since dropped 28 per cent to 174p.

Helping to balance these is the predictability of Warehouse REIT (WHR), which owns a £900m portfolio of ecommerce warehouses in the UK generating a rent roll of £44m. With predictable income, Warehouse levers up equity returns via borrowings and distributes almost all its net profit. Also in terms of predictability, the likes of floorings supplier James Halstead (JHD), a long-term Investors’ Chronicle favourite, and palm-oil plantations owner MP Evans (MPE) are close. Meanwhile, growth potential would most obviously be supplied by Smart Metering Systems (SMS), whose chief function is to install the smart domestic electricity meters without which the UK’s network operators will struggle to run the electricity grid in the coming decades.

As I say, this is less a portfolio and more the suggestion, 'how about something like this?'. Even so, it will be interesting to see how it has performed in a year’s time.

bearbull@ft.com