Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today is Hugh Yarrow, Manager of the Evenlode Income Fund.
Hello Hugh.
Hugh Yarrow: Hi Emma.
Wall: So, you're here today to give three stock picks. What's your first stock for us?
Yarrow: My first stock is a healthcare company, AstraZeneca (AZN). Now, I like healthcare. Long term, I think the fundamentals look attractive. I think the combination of innovation, emerging market growth and long-term demographics mean that the demand profile and the sorts of products that pharmaceutical and other healthcare stocks sell looks very attractive.
I also think that the valuation of these stocks currently looks quite good. Investors have got pretty fed up with them over the last few years. Declining production of pipelines has meant that a sector that was very fashionable in the Ninties has gradually been de-rated and actually investors give the pipelines of new therapies that are coming through very little credit in today's market.
Wall: I think everyone is familiar with the sort of patent story, perhaps less so in the pharmaceutical sector is the competition from some of the massive U.S. pharmaceuticals who have been doing a huge amount of innovation and actually acquiring smaller companies to help broaden their knowledge base. Is that a threat for Astra?
Yarrow: Well, all of the healthcare companies, clearly that it's a competitive environment and with some of the changes in the U.S. healthcare system as well there has been pricing pressure over the last few years and that will remain a threat and a risk to the sector. But as long as the sector remains innovative and is genuinely producing products that help people and healthcare systems, these drugs and therapies they work as a displacement factor.
Wall: What's the second stock today?
Yarrow: The second stock is a software company, Sage (SGE). It's the global market leader in providing enterprise software to small and medium-sized businesses. So, it's got six million customers around the world, 160 countries that it operates in, very globally diverse and these products like accountancy software become very embedded in the day-to-day workflow of its customers.
So, recurring revenues which come from support contracts and subscription are growing faster than the overall business and currently make up nearly three quarters of overall revenue and those recurring revenues are renewed at a rate of more than 80% a year. So, there is a nice solid reassuring cash flow there. And the business is very asset-light. It doesn't have much to spend in terms of capital investments. So, routinely converts the profits that it makes into cash flow.
Dividend growth has been very strong. It's been more than 10% per year over the last 10 years and 9% over the last five years and the most recent dividend increase was 9%. The current yield is about 3%. So, it's not the highest yielder, but given the cash-generative qualities of the business and the steady growth, we think that dividend growth in the future should be very good.
Wall: What about the third stock?
Yarrow: The third stock is a smaller company and that's an area which we've been increasingly less interested in smaller companies over the last few years because they have been in a very strong bull market. But we've seen selectively a few more opportunities come up again in the last year or so and one of them is Domino Printing (DNO). It's a Cambridge-based seller of printers to people like Nestlé and Pfizer, big manufacturers of fast moving consumer goods and pharmaceutical companies and it prints best before dates and inline variable batch numbers onto fizzy drinks cans and pharmaceutical packs.
The new printer sales is part of the business but then the customer wants those printers to work very well. So, Domino Printing will also sell printer ink and also will supply spare parts and servicing to the printers. So, there is a nice again recurring cash flow stream that comes from that aftermarket business for Domino. Now, Domino Printing shares didn't perform very well last year. They fell quite sharply. The company came out with the statement saying that new sales of printers in Asia had slowed somewhat. It is a very globally diverse business. But we still remain very interested in the qualities of the business model.
Wall: Hugh, thank you very much.
This is Emma Wall for Morningstar. Thank you for watching.
