97. Why we could be through the worst of the UK dividend cuts

8 October 2020 (pre-recorded 5 October 2020)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Chris Salih (CS): Hello and welcome to the Investing on the go podcast, I’m Chris Salih and today we’re joined by Job Curtis, manager of the Elite Rated City of London investment trust. Thank you for joining us today.

Job Curtis (JC): Good morning, thank you.

[INTERVIEW]

[0:15]

CS: The trust has the best track record of any investment trust for dividend increases, having raised its dividend for 54 consecutive years now, and it’s been able to achieve this by dipping into its revenue reserves on occasions when income has really been hard to come by. Obviously this year 2020 is a prime example as UK dividends has sort of been slashed indiscriminately across the board due to lockdown and sort of unforeseen circumstances.

I guess the first place to start is, I mean, could you talk us through how the companies you hold have held up and maybe how much of the revenue reserve you’ve used this year and how much do you still have left given the challenges that are ahead?

JC: Yes, this has been a very difficult year for dividends and almost half of FTSE 100 companies either cut or passed their dividends during the course of the year. The core of our portfolio was very solid – our biggest sort of group is consumer staples, these are the makers of everyday products. And in fact, the three biggest holdings in the fund are BAT [British American Tobacco], Diageo and Unilever, and that’s been a very solid area for dividends and some 22% of our portfolio including supermarket groups like Tesco and Morrison in that category.

Then, you know, we have 9% of pharmaceuticals, again very solid, other areas being defensive like utilities and telecommunications, the overseas stocks we hold there. But having said that, you know, we have been affected inevitably, I mean two areas typically with weakness were the banks, which were banned from paying dividends and we’ve had to reduce them. They’re much better condition than they were in the financial crisis, but they are leveraged institutions and sensitive to economic activity and also travel and leisure where we took a view, this area would be very hard hit and slow to recover because of social distancing. So we did reduce in those areas.

So in all, we took about £14 million from our revenue reserve. So, it did help, you know, we’ve been putting into revenue reserves for the last six or seven years. And so, you know they’re there for a rainy day, if ever there was a rainy day for the events, this was it, but we still, having taken £14 million out, we’ve still got around £46 million, £45 million in revenue reserves. So you know, and we, we do model different scenarios of dividends and we have three main scenarios and even on the most pessimistic our revenue reserves would be sufficient for the next four years. So we think we are, you know, we’ve used the advantage of an investment trust to use this revenue reserves, to increase our dividend by 2%, as well as the dividends we received from the core of our companies, which have been very strong.

[2:50]

CS: You mentioned there the three based scenarios, could you maybe talk us through your outlook for dividends for next year and which scenario you think is perhaps most likely of the three and maybe talk us through some of the companies that have perhaps started reinstating dividends or have they, and maybe just talk us a bit through the outlook for that as well?

JC: Yeah, I think it’s been a huge reset with, you know, a lot of dividend cuts across the market, and some companies you know, the outlook was so unclear. You know, in April, March, May, that there were some companies who could perfectly easily have paid a dividend and didn’t pay a dividend that point. So we actually have seen in the autumn and the half year reports from companies quite a few dividends coming back from the portfolio and examples in our portfolio with BPA systems, big defense contractor, Direct Line insurance group, Ferguson, which is a big builder merchants in America. These are all companies that really out of an abundance of caution didn’t pay dividends back in April/May, and they just paid that interim dividend, so kind of paid us the dividend that we were owed back in that period.

So I think there’s, I think there’s been a large reset. I’m pretty confident most of the big companies that were going to cut their dividend have had done so. So, it’s kind of more of a question of going forward. You know, to what extent do you just flat line and do nothing from here? Or do we make a modest recovery? Do we make quite a good recovery? I mean, so far signs have been quite good. We’ve actually had quite a good recovery in the last couple of months with companies coming back through the list and only time will tell and obviously a lot depends on how the economy recovers. But overall I’m very confident we’ve seen the worst of it, certainty the short term indications are that we’re going to enjoy quite a nice recovery in dividends.

[4:40]

CS: And I wanted to perhaps look at a couple of sectors in a bit more detail. So perhaps could we talk about oil and tobacco? You’ve been quoted recently as saying that the oil industry is in a state of managed decline, much like tobacco has been over the past decade or so, and obviously you still hold both of them in your portfolio. So maybe tell us, is it possible take money from these industries that are in decline and if so, how?

JC: Yes, it certainty is possible, and the tobacco sector over the years has been a very good sector for dividends and profits, despite it being a declining industry. You know, I still feel this tobacco sector, I mean, we haven’t got a huge position, but we do have, we are overweight BAT, Imperial Brands, and we’ve about 7% of the portfolio in tobacco and this is a very good area for dividends, and helps underpin our dividend commitment and you know, they managed… they have been very good at managing decline, the leading companies in that sector.

I mean, oil and gas, I think the issue is this transition to a kind of greener economy with more electricity and, you know, in the long run, it probably does mean a decline in demand for oil and gas, but I think it’s going to be quite a slow process. We’re very dependent on oil. And it’s a question of how well the companies manage it. If they can spend their capital expenditure more efficiently and target it in a more efficient way, then that could be quite positive for investor returns. I mean, it’s a huge area. We are actually underweight compared to the index in oil and gas. We got less than the market averages in both Shell and BP who both cut their dividends. But they’re probably cut back to a level, which they can really afford now. They were probably too high previously, so I’m not inclined to sell out of it at these levels. And I’m hoping it’s still an unknown, how they do manage transition. They’ve talked about investing more in renewables. There’s a lot of uncertainty about what kind of returns they can achieve in that. So you know we’re underweight, but we do have, we do have some exposure in oil and gas through Shell and BP.

[6:42]

CS: And maybe could you touch upon what your outlook is for the UK generally at the moment? I mean, obviously there’s another Brexit deadline looming, and we’ve had these, sort of, the Damocles of Brexit hanging over the economy for a number of years now. We’ve also got a number of local lockdowns and the government’s also starting to replace some of its schemes, generous schemes shall we say with less generous ones? I mean, does that worry you, does that impact you? How are you approaching that?

JC: The Brexit is a difficult one. You know it’s just so hard to read with, you know, the rhetoric from both sides and also people laying down that kind of negotiating position, but what the real true position is, but it’s certainly the thought it’s in both the interest of the UK and the EU to have a deal. You know, it’s got, you know, both sides will benefit from a, from a deal, say one is hopeful, but you know, that one will be reached.

I think in terms of the economy and it’s weak, obviously we’ve had a lot unprecedented lockdown in Q2. So GDP fell by 20% and then this economy reopened, you’ve had a very big bounce in economic activity. Some of these government schemes are rolling off or changing. We’ve had unprecedented fiscal and monetary stimulus from both the government and the Bank of England to help the economy through, you know obviously having been locked down because of the virus, but I think the economy, the UK economy, has shown quite a lot of flexibility over the years. This is a really tough one being thrown at it, but it’s, you know, other countries have got the same. And obviously we need to adapt to new circumstances, but I’m pretty confident overall. You know, I think that the government’s going to be very keen to avoid another national lockdown and go for more the regional, local lockdowns because they’ve got to weigh up both the virus and the danger of the virus. Also the other health risks and the state’s economy generally.

So I think we’ve seen the worst of it, but it’s, but it’s obviously very uncertain in terms of a vaccine. Experts within our company are confident the vaccine will be come, come on the market probably early next year. But so not quite as soon as some people expect, but then apparently of their trials, their view is the trials are very promising in terms of vaccine.

[8:55]

CS: And just finally, international sort of investors have seemed to be shunning UK equities and even Brits seem to be shunning the home market. I mean, the data on outflows is sort of quite depressing really. What would you say to sort of convince people that UK PLC is still open for business and there are still strong companies to sort of take opportunities within the UK?

JC: Yeah. The UK has been very out of favor. I mean, Brexit may play some part of it, but I think it’s been more recently the fact that, you know, one of our great virtues has been our dividend track record in the UK, and we’ve had so many dividend cuts as we were discussing earlier. So I think the extent to which investors can get a feeling that actually we’ve turn the corner on dividends. So I think that could attract money, particularly people looking for income, back into the market. There’s no question the UK is looking very cheap relative to other markets. And, you know, if the news is not quite so bad, as people are fearing and you know, whether it’s Brexit or the virus or growth generally, but things go slightly better than people are fearing then, then I think, you know, UK is set up for quite a strong bounce. So that’s my personal opinion.

CS: Okay. That’s great Job. Thank you very much for joining us today.

JC: Thank you.

CS: And if you’d like to learn more about the City of London investment trust, please visit fundcalibre.com and while you’re there remember to subscribe to the Investing on the go podcast.