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Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by George Boyd-Bowman of Neptune. He runs the Global Income Fund and is here to give his three stock picks.
Hi, George.
George Boyd-Bowman: Hi, Emma.
Wall: So, what's the first stock today?
Boyd-Bowman: So, the first stock I want to talk to you about today is a company called Devro. This is a Scottish company that is actually one of the leading manufacturers of sausage skins globally. Really this is a great example of what we call dividend special situations. So, that's when there is a catalyst for the dividend to either start growing more quickly or indeed start growing again after a period of no dividend growth.
So, what we like about Devro (DVO) is that it had actually been growing its dividend really quite nicely post the financial crisis up until 2014, but then something changed and the last couple of years they haven't grown their dividend. Instead, they have actually been reinvesting in their business. So, they have been building two new factories, one in the U.S. and one in China. The important thing is that both of those factories complete this year.
So, when they complete this year the CapEx that they have been spending will fall back down to more normal levels, the free cash flow rises again and that's what's going to enable them to drive the dividend on once again and this is really important. So, it's actually this temporary period of no dividend growth today that we believe gives you the opportunity to buy a future dividend aristocrat or dividend champion, if you like, at an attractive valuation.
Wall: What's the second stock?
Boyd-Bowman: The second company I'd like to talk to you about is a company called AMADA (6113) and that's a leading Japanese industrial company. It's actually a machine tool manufacturer. This is an example of a company that's benefiting from the emerging dividend culture in Japan and that's a result of those corporate governance reforms that we've seen over the last couple of years. In fact, AMADA is a direct beneficiary of that. So, the Nikkei 400…
Wall: The Shame Index.
Boyd-Bowman: The Shame Index, exactly, is generally agreed to have been the fact that they kicked off corporate governance reform in Japan. It's the index that has a return on equity threshold. Companies can't get in that index if their ROEs are too low and one of the main reasons for that is that they have got too much cash on their balance sheets.
So, the story goes with AMADA that the presidents of the company when they weren't included in this index at the beginning of 2014 just a few months later at their next full year results, he was so incensed that they dramatically changed their shareholder return policy and took their dividend payout ratio up to 50%; they took their buyback also up to 50% guaranteeing that at least 100% of profits will be paid back to us as shareholders.
What really interests me about this company is they are still not in that index. So, despite radically changing their policy, we're expecting further shareholder-friendly actions over the next couple of years.
Wall: What's the third and final stock?
Boyd-Bowman: So, the third company I want to mention is a company called Bridgestone (5108) and that's the leading tire maker based in Japan, another Japanese company and another example of a company that's benefiting from this emerging dividend culture in Japan. Aside from that, which we'll come on to, we also like Bridgestone because it's a beneficiary of a theme we like at Neptune, that's lower for longer oil.
So, this company benefits from increasing miles driven as a result of a lower gas price, particularly in the U.S. and that has obvious implications for the replacement cycle of tyres.
The second, as I mentioned, the emerging dividend culture in Japan brought on by these corporate governance reforms as a key part of the Third Arrow, so Bridgestone a couple of years ago had a pitiful payout ratio, just 30%, well below its key peer Michelin here in Europe. Now that's already changed. The company is already making improvements. It's raised it up to 30% and that happened at the launch of its new medium-term plan at the end of 2014, but we think that payout ratio can rise towards 40% over the next couple of years.
Now that not only leads to a good outlook for dividend growth but also it should help to close the discount between them and Michelin. They still trade at a valuation discount to Michelin. We think that's unwarranted and the improvement in dividends should help to close that gap.
Wall: George, thank you very much.
Boyd-Bowman: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
