Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today to discuss his three U.K. stock picks is Matt Hudson, manager of the Schroder U.K. Alpha Income Fund.
Hello, Matt.
Matt Hudson: Hello.
Wall: So what's your first tip?
Hudson: Well within the media sector one of the big holdings in my fund is Pearson (PSON). Pearson has been a traditional media company that is now moving into the digital age and as it does so, it is improving the long-term growth characteristics. It's a company that's been under a bit of pressure over the last couple of years and earnings have come down.
But we feel that we are behind all of those earnings downgrades, you are getting a premium level of yield with dividend growth and we should expect to see revenue growth at Pearson pick up over the next couple of years. So, later cycle asset, dividend growth, but with a high-yield at the same time.
Wall: Of course, print media as you did mention there, has been under the cosh in the last sort of decade. Does it have enough momentum to make that jump, because not everyone is going to do it successfully?
Hudson: No, true. But if you look at Pearson's end markets and you look at the very strong market shares they have in a lot of these growing markets then you should have – I think as an investor have a quite a lot of confidence that they can get there. It is true it is a difficult transition that is fair and that's why we have seen the earnings numbers change over the last couple of quarters.
But I think, as said before, we are probably in a stage where the growth is beginning to accelerate and with earnings growth you should get dividend growth as well.
Wall: What's the second stock then?
Hudson: Well the second stock is perhaps a little bit more controversial. It's Friends Life (FLG) within the life assurance sector. It's a company that came about from a range of different acquisitions and has been very successful at managing its back book. The company is now looking to grow, to looking to grow their front book of business and start to move the earnings forward.
But at the same time it's had a high-yield, a big premium to market, but it’s trading on about 30% discount to embedded value. So we see a lot of value, a high-yield and potentially in the future some actually positive momentum coming from the business.
Wall: How exposed are Friends Life to the annuity market, because of course we have seen some of the large insurers like Aviva have their fair value estimate dropped because of the scrapping of the annuity business? Is this going to reflect the stock?
Hudson: I think it already has and that's why we are interested in it. It already had a big discount embedded in the stock price for those problems and in some ways, this company Friends Life has been managing in this – in what is a challenging environment, the workplace environment for a long period of time and really they have got a lot of expertise in this area of back book and potentially in providing new product.
So there is always going to be a need for that investment. It might be provided in a different way to annuities, but you are always going to need to have that pool of assets there and this company we think is well set to actually manage that and provide returns for shareholders as well.
Wall: And what's your third and final stock?
Hudson: My third stock is BT (BT.A). It's an asset that's been in the fund for quite a long time and what we really like about it is the dividend growth characteristics. It's no longer yielding a big premium to market, but the management have been able to take a lot of costs out. That's allowed them to accelerate their top line revenue growth and we have seen them bidding for some new sports rights to having to help them grow their book of business.
And of course, as the top line grows, then you should expect to see earnings pick up as well. So a company transitioning from perhaps high-yield utility like returns to something a little bit more growth and we should expect to see double digit dividends and earnings growth going forward.
Wall: I personally have been very happy about being able to see the rugby Premiership for free, but a lot of analysts have been mixed about how successful that offering has been and suggested perhaps BT should have stuck to its core market.
Hudson: Sure.
Wall: How do you feel about that?
Hudson: Well, I think, you have got a lot more credibility to their offer now than what we have had historically. And the entire pay-TV market and telecoms are beginning to converge and really I see this, BT in particular, as one of the key players in this convergent strategy and having a lot more credibility in that offering now than they have ever had historically.
So of course there are risks, risks not only in media content costs, but in other areas as well. But actually if you look where we are now from this business, I think you have got a stronger visibility on where the revenue is going to go and that should help to say drive dividend growth.
Wall: And they have got the cash to do it again?
Hudson: They have got a stronger balance sheet than historically, because they have improved their cash flow returns. So they are capable of doing deals as we have seen and maybe we'll see a few more coming through the next 12 months or so.
Wall: Matt, thank you very much.
Hudson: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
