Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Stephen Message, Manager of the Old Mutual U.K. Equity Income Fund to give his three stock picks.
Hi Stephen.
Stephen Message: Hi there.
Wall: So what’s the first company you'd like to highlight today?
Message: So the first company I'd like to highlight is Vodafone (VOD), mobile telecoms operator, principally in Europe, these days. What the business did, it sold the majority of its stake in Verizon Wireless U.S. business. And it's used the proceeds – part of the proceeds from that sale to reinvest in to its European markets to ultimately improve levels of customer service, to improve network levels, to ultimately drive a better performance for its customers.
You should then hopefully see the performance of the business improving. The big trend which is going on in mobile telecommunications at the moment is the adoption of 4G services and data services and typically when you move from 3G to 4G your data usage typically doubles.
Vodafone is really seeing quite significant benefit from that. Because ultimately it starts to charge more for its product. So it has invested in these products, starting to charge more for it which ultimately means it has got pricing power. Pricing power I think we haven’t seen in telecoms for quite some time. And probably if you start picking your prices up than as an income investor the dividend to me start to grow quite nicely as well. So everything starting to move in the right direction for Vodafone. A dividend yield, of 5% today with finally some potential to grow that dividend as those cash flows improve supported by the better prices makes quite compelling investment case over the next few years.
Wall: Now there has been quite a lot of consolidation within the mobile telecoms industry across Europe. We've had a deal recently not being allowed between EE and O2. But that is the way the things are moving. We're moving towards a sort of three player market. Is that going to affect Vodafone?
Message: Yes, so the regulatory stance has moved around a bit. For Vodafone one of the key positives was in Germany which is one of their largest markets. We did see a merger from four to three operators which ultimately consolidation means. You should get a more disciplined competitive environment should lead to more sensible pricing. But actually it’s gone slightly the other way. For example, in the U.K. at the moment which is just we are not fully yet there.
So what I am thinking about Vodafone from here there is a proposal for a merger in Italy for example where Vodafone operates, going to four to three that hasn’t happened yet. So the regulatory stance is still a bit of a risk for the company. But I am quite pleased for example in Germany that has come through and you are starting to see the benefit of that in Vodafone's numbers.
Wall: What's the second stock today?
Message: So the second stock I would like to highlight would Lloyds Bank (LLOY). Domestic retail bank it's got a large share in the mortgage market around 20%. It's been quite a journey over the past few years especially as an income investor. It didn’t pay dividends for a number of years it was absent from the dividend register for about six and half years. It returned to the dividend register last year and few months ago we saw the dividend step up slightly.
In fact, we got a special dividend. So we are going from a scenario where a business hadn’t paid a dividend for quite some time. They have returned to the dividend register and we are at a point now where the capital position is a lot better for the company, much more adequately capitalised. They are paying dividends, in my view the regulatory stance, we have the Bank of England passing bank stress test for that business as well. Suggests to me that the scope for dividend payment is going forward can be quite meaningful at Lloyds to the point where we think the shares could be yielding anywhere up to 6% or 7% or 8% over the next few years. As those returns and the balance sheet is in a lot better shape.
Wall: They have taken their punishment and they have come out the other side.
Message: Absolutely. And it's gone from a point where I think a number of investors haven’t really looked at it for quite some time. Because it hadn’t been paying dividend. But these dividends in their absolute sense and the magnitude of dividends, they are meaningful dividends we're talking to north of £1 billion worth of dividends. So I think a lot of people will start looking at Lloyds again and I am very happy for it to become a boring retail high street bank going forward. Where the dividend payment should be quite attractive and growing.
Wall: And what's the third and final stock.
Message: So the third one I'd like to highlight is a mid-cap company. This is a company called SSP Group (SSPG). It came to the market a couple of years ago, it's one of the IPOs that we did support. The interesting thing with this company, is it's been run by a manager with a good track record of delivering within the travel market. Kate Swann who worked at WH Smith growing the travel franchise there. And we think the operating margins SSP can really start to improve as they focus on some of the key matters within the business.
So reducing waste, looking at better levels of staff resourcing for example. Just doing procurement a lot better than they had done in the past. If you put all these things together, you can build a scenario where the margins low single digits at the moment can grow quite nicely over the next few years and similar to the case with Vodafone earlier on. That should mean the scope for dividend growth is quite strong.
Wall: Stephen thank you very much.
Message: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
