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10 Safe Yield shares

The Safe Yields screen substantially outperformed the market over the past 12 months and, with a bit of tinkering, has been able to come up with 10 share picks for the year ahead.
August 11, 2020

The focus of this week’s screen is to find shares that offer attractive and relatively safe dividend yields. Events since lockdown mean it may feel as though the concept of a 'safe' yield is in tatters. In fact, income-hunters were having the concept of 'safety' tested for several years before Covid-19 hit with headline-grabbing cuts in 2019 from erstwhile income stalwarts such as Marks & Spencer and Vodafone, for example.

One favour Covid-19 may have done income-hunters is shaking out many of the market's flimsiest dividend-payers. For many such companies, while the pain of lockdown is real, it has also provided a cover to make dividend cuts that had looked inevitable for some time. Among the highest-profile companies to have succumbed to reality this year are Shell (RDSB), BT (BT.) and, most recently, BP (BP.).

One key tactic used by the Safe Yields screen to avoid the type of disappointment associated with too-good-to-be-true yields is to simply not be too greedy. Specifically, the dividend criteria used by the screen is undemanding, requiring that shares only need to offer a yield of 3 per cent or more. That said, with interest rates at near-zero around the world, even 3 per cent could be considered to be a bit punchy these days. One of the relaxations I’ve made to the criteria of the screen to boost results (see below) accounts for this by lowering the yield criteria to 2 per cent. 

Another change to the screen this year is that the old yield test has been firmed up a bit by requiring both the forecast and historic dividend yield to be over 3 per cent. This in part reflects the fact that the new data provider we’re using to power the screens offers us comprehensive coverage of consensus dividend forecasts. But the use of forecasts is also a nod to the fact that many shares are predicted to cut their payouts. This is very unusual as dividend forecasts tend to get far less attention or revision than earnings forecasts and are rarely a very useful guide. The exceptional circumstances of lockdown have made things different this year. 

Despite the tough times for dividends, the Safe Yield screen actually put in a very strong performance over the past 12 months relative to the market with a total return of 1.7 per cent compared with a negative total return from the FTSE All-Share of 15 per cent. Some of the more cyclical stocks selected, such as Norcros (NXR), Morgan Sindall (MGNS) and MJ Gleeson (GLE), have come a cropper since the market’s January peak. But other stocks held up well. 

 

12-month performance

  Total return from 15 Jul 2020
NameTIDMto peak (1 Jan 2020)04-Aug-20
Polymetal InternationalPOLY29%106%
Liontrust Asset Man.LIO61%66%
Sirius Real EstateSRE38%17%
Morgan SindallMGNS54%-5.5%
BritvicBVIC1.2%-6.3%
VPVP.22%-14%
VesuviusVSVS-11%-20%
MJ GleesonGLE26%-22%
Paragon Banking GroupPAG15%-22%
NorcrosNXR33%-32%
TBC BankTBCG-18%-48%
FTSE All Share-5.7%-15%
Safe Yield-23%1.7%

Source: Thomson Datastream

 

Over the nine years I’ve followed the screen it has produced a 154 per cent cumulative total return compared with 53 per cent from the FTSE All Share. While the screen is meant as a source of ideas for further research rather than an off-the-shelf portfolio, if I factor in a 1.5 per cent notional real-world annual dealing charge, the cumulative return drops to 122 per cent. 

 

 

The problem faced by the screen this year is that no stock passes all its criteria. Part of this is due to the fact that earnings and dividends are forecast to fall for so many companies as a result of lockdown. The difficulty here is that the more I relax the screen’s criteria, the fewer shares are likely to fit the 'safe' billing. Meanwhile, the lower the yield I require the less fitting of the description of 'income' picks they are likely to be.

Given the paucity of positive results I’ve decided to play both angles. In the past I’ve relaxed the screen by allowing shares to fail one test as long as it is not the dividend test. Only consumer goods group Unilever passes on this basis. Two other stocks pass on this basis if I reduce the yield requirement to 2 per cent (Spectris and Polymetal). To bulk the screen results up further, I have allowed shares with a 3 per cent-plus yield to fail up to two tests, which gets another seven results. It is disappointing to have to resort to such tactics, but a reflection of the times the market is going through.

The full criteria are:

■ Dividend yield of at least 3 per cent.

■ Dividend cover of at least two times.

■ Interest cover of at least five times.

■ Dividend growth in each of the past three years.

■ Forecast earnings growth in each of the next two financial years.

■ An average return on equity over the past three years of at least 12.5 per cent.

■ Cash conversion (measured as cash from operations as a percentage of operating profit) of over 100 per cent.

■ A market capitalisation of at least £250m.

■ Beta of 0.75 or less.

The shares passing the weakened screen are in the table below. I’ve also taken a closer look at the highest yielding share. As a rule of thumb, shares offering a yield of over 7 per cent – 6 per cent is also not a bad cut-off – should have their dividends regarded with extreme suspicion. This means Imperial Brands' (IMB) 11.3 per cent yield should ring major alarm bells. That said, there are some interesting changes afoot at the tobacco company and, while risky, its shares look as though they could offer quite remarkable value.

 

10 Safe Yield shares

NameTIDMIndustryMkt CapPriceFwd PE (NTM)Fwd DY (NTM)DYEV/SalesEV/EBITEV/ EBITDAPEGGV RatioP/BVFCF Conv.EBIT MarginROCEFwd EPS grth FY+1Fwd EPS grth FY+23-mth Mom3-mth Fwd EPS change%12-mth Fwd EPS change%Net Cash / Debt(-)*
Spectris plcSXSElectrical Products£3.0bn2,586p212.3%0.8%2.01610--2.354%12.4%14.5%-37.7%26.9%-3.6%-14.4%-37.9%£-34.5m
Unilever PLCULVRHousehold/Personal Care£53bn4,539p203.5%3.2%3.116149.13.08.499%19.4%26.1%2.2%5.7%11.2%0.1%-5.6%£21bn
Moneysupermarket.com Group plcMONYOther Consumer Services£1.7bn308p203.7%3.8%4.41513--8.4113%29.9%53.7%-23.4%22.1%-5.7%-23.1%-23.8%£-7.5m
Sirius Real Estate LimitedSREReal Estate Development£778m75p144.6%4.2%8.520192.01.81.123%-5.4%6.6%20.3%13.3%-20.2%-15.3%£335m
Polymetal International PlcPOLYPrecious Metals£9.5bn2,012p124.6%2.5%6.117130.40.36.553%35.3%23.2%54.7%17.7%22.4%7.7%57.2%£1.1bn
GlaxoSmithKline plcGSKPharmaceuticals: Major£78bn1,555p135.1%5.1%3.11515--5.7109%22.3%21.5%-6.0%2.6%-7.1%0.8%1.7%£23bn
Rio Tinto plcRIOOther Metals/Minerals£58bn4,670p125.6%6.4%2.676--2.4136%31.9%25.8%-11.9%-12.6%25.3%11.9%-23.1%£6.4bn
Chesnara PlcCSNLife/Health Insurance£418m279p138.0%7.6%0.3----0.9-64%---59.8%4.3%-14.6%6.7%-14.9%£14m
British American Tobacco p.l.c.BATSTobacco£57bn2,492p79.0%8.4%4.0984.00.90.8114%42.3%9.7%2.0%6.7%-16.3%-1.8%2.0%£45bn
Imperial Brands PLCIMBTobacco£12bn1,249p511.3%14.9%1.6127-1.42.8218%17.0%16.6%-6.5%3.5%-23.2%-2.2%-9.4%£14bn

Source: Factset

 

Imperial Brands

Growth is not always in the interests of shareholders. If the opportunity for growth does not exist, or if the return from growth does not justify the required investment to achieve it, then companies would do better simply returning any extra cash to shareholders or using it to address balance sheet issues, such as debt or pension deficits. 

While Imperial Brands (IMB) certainly has not been shy about returning cash through dividends, it has also invested fruitlessly in growth for several years. The experience has been costly and disappointing, with the group’s sales projections for next-generation products (NGP), such as vapes, proving wildly optimistic. Its NGP fortunes have not been helped by growing health concerns and regulation, particularly in the US. Covid-19 could result in further regulatory pressure.

As illustrated by the accompanying chart, over the past 10 years there has been little convincing sign of growth taking hold. Meanwhile, the trajectory of forecasts over the past two years (see chart) tells of dashed dreams. Despite the dependable end market, next-12-month consensus EPS forecasts are down a tenth in the past year.

 

 

Meanwhile, the company has raised eyebrows for a perceived aggressive approach to accounting. Its track record for earnings adjustments has added to scepticism, especially when considered alongside the company’s frequent earnings disappointments.

 

 

But the hope now is that the company is finally experiencing its cathartic moment. The boardroom has been overhauled with a new chairman appointed last year, a new chief executive taking the helm at the start of July, and news earlier this month that the finance director will be replaced, too.

Even prior to the arrival of the new chief executive, the company was busy resetting expectations. After several years of pursuing a policy of growing the dividend by 10 per cent a year, the company scaled the payment back by a third at the interim stage. It also took a number of charges against goodwill and slow-moving stock (stock-to-revenue has been creeping up for a number of years). What’s more, it included in its adjusted earnings a number of costs that in prior years would probably have been considered as 'one-off'.

The company has also finally concluded the sale of its premium cigar business, which has involved a litany of write-downs and will result in a dilution to earnings.

The valuation of the shares suggests investors are still not convinced that the decks are fully cleared. The chief executive could have a so-called kitchen sink warning in store – a massive round of write-downs and provisioning to provide a clean slate and substantially lower expectations from which it is easy to make progress.

Given the despairingly high level of the dividend yield and the derisory price/earnings (PE) ratio, the company could potentially create credibility with a noteworthy restatement of past profit and a further dividend cut, even though historic cash flows actually suggest the rebased dividend should be supported (see chart below). But sometimes, especially after a major management change, such contrition from deeply unpopular companies is rewarded in share price terms. 

There is also the important question of what the group’s strategic direction will be under new leadership. It is a brave chief executive that goes against the instinct to pursue growth. But running this business to produce the best return for shareholders may simply involve making the best of what Imperial Brands already has rather than trying to repeat what has failed so decisively in the past: trying to grow. 

 

 

The company’s traditional cigarette and tobacco business generates lots of cash. Focusing on this attribute while paying down net debt of £13.5bn (already a stated policy) could be enough to prompt a reassessment by investors. That said, based on reported cash flows there seems little pressing need to strengthen the balance sheet. 

If credibility can be re-established, there’s scope for a substantial rerating based on the shares’ eye-popping historic free cash flow yield of almost 20 per cent. Indeed, based on Factset data, free cash flow from the past five years of £11.6bn is only just shy of the company’s current market capitalisation of £11.8bn.

Imperial shares should definitely not be regarded as “safe”, which is implicit in the extremely low valuation. However, with change afoot and a defensive end market, there is the potential for a lot of “value” to be unlocked. The shares are only for investors prepared to buy into a morally-dubious sector and sensibly balance the risk.