Market Outlook: Income Paying UK Stocks

Emma Wall: Hello, and welcome to Morningstar's Investing for Income Special. I'm Emma Wall and here with me today is Sarah Emly, Manager of the Claverhouse Trust (JCH).

Hello Sarah.

Sarah Emly: Good afternoon, Emma.

Wall: So the trust has managed to – or the managers of the trust have managed to – grow the dividend of Claverhouse for 41 years, even through the performance blip of the financial crisis. How did you manage that?

Emly: That is one of the key benefits of being a closed-end investment trust. The fact that during the good times, the directors of the investment trust, Claverhouse in this case, they had sensibly put some of the revenue generated in the good years into reserves so that when there is an unexpected event such as the financial crisis, you've got the reserves that you can then dig into in order to smooth the dividend payments to our shareholders; and it was interesting because not only do we have the financial crisis, where you have many banks canceling dividends, but then two years later, you had the Macondo crisis and BP (BP.).

So things were looking better in terms of the dividend outlook for U.K. equities, but then you have the Macondo crisis where BP were forced to suspend and then cancel the dividend. So Claverhouse like a few other investment trusts has got a very strong long history of delivering dividend growth to its shareholders; but the encouraging thing in the year ending December 2013 was the fact that we actually managed to cover up the dividend payment through our revenue generation. So, it was a good statement made to our shareholders, which includes the managers ourselves, myself and William Meadon, we're shareholders in Claver as well.

Wall: You mentioned there are, a couple of challenges that have faced income investors. Banks made up a big part of most income portfolios, closed and open-ended funds, and then the BP disaster as well. I mean things have improved, the stock market has moved up. How much has the environment improved for income investors?

Emly: Well, it has been in stages, and if you look at what the U.K. equity market has delivered in terms of earnings growth and then dividend growth since the beginning of the financial crisis, it's been a very different picture. Earnings, profit, corporate profits and corporate earnings have fallen for several years in a row, but despite that, over the last couple of years, you have actually seen dividend growth from many U.K. equity companies. So even though the market earnings were still declining, last year 2012 and 2011, you did start seeing dividend growth coming back to the market.

I think that's an increasing feature, because as a result of the financial crisis, many corporate top management teams, they've become increasingly focused on reducing their gearing, lowering their debt and focusing on generating cash from their operations; and as the economies gradually recovered, you have actually seen that increased cash generation come through to dividends.

So, we've had reasonable dividend growth from a good number of companies. Imperial Tobacco (IMT), they've increased their dividend 10% every year for a sustainable period of time due to their focus on cash generation. You've had other companies who have a higher starting or a higher starting dividend yield, but more mediocre growth, but at the same time, you had some companies which have been so strong at generating cash. They've delivered strong growth in their base dividend, plus special dividends.

An example of a stock that we've held in Claverhouse for a long time is ITV (ITV), the television broadcaster. I mean they've had strong dividend growth since the new management team of Adam Crozier and Archie Norman as Chair took over, focused on cost cutting, diversifying their revenue stream. So they've delivered strong dividend growth, but on top of that, we got a four piece special dividend last year, and then we got another one in the first quarter of – well, announced in the first quarter of 2014.

So, I think it's been a very good sustainable recovery, not yet from all the banks, and I wouldn't bet all my income powers on a bank delivering a sustainable dividend growth, but many other companies have really taken sensible and good measures and have been delivering good dividend growth, since the financial crisis.

Wall: Can investors expect more the same, because I think a lot of people are expecting, certainly equity markets to plateau or slowdown, will the same happen with dividend growth, what's next?

Emly: Well, I'd say, it really depends from company-to-company. I mean, if we look at what the U.K. equity market delivered to investors last year, the actual FTSE All-Share Index rose by 20.8% in calendar 2013, which was an exceptional year. I mean, there's no way that we would expect such a rate of high return to be delivered year in, year out; but if you look at what was actually delivered in terms of dividend growth, it was more modest.

So, I think going forward, we do still expect dividend growth to come through, but it will vary from company-to-company, and also there were difference outlooks depending on whether the company is domestically focused, sterling, pound-sterling, revenues, costs and dividend declared or whether it's a global player like the mining stocks, like the big major oils and indeed the pharmaceuticals who get a lot of their revenues in dollar denominations and that does have an impact on the dividend growth.

But what we've seen so far in 2014 is many of the more domestic companies delivering strong dividend growth plus specials, and it's been a bit more of a challenge for the more globally-oriented ones, but we keep a very close eye on what – where we think the growth is going to come from, but I think if you've got a sensible focus, but still diversified portfolio of equity holdings. You can deliver dividend growth to your shareholders and that's what we're focused on doing; to try and maintain that 41-year record going forward.

Wall: Sarah, thank you very much.

Emly: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.