Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today to give his three stock picks by Colin Morton, Manager of the Franklin UK Equity Income Fund.
Hi Colin.
Colin Morton: Hello there.
Wall: So what's the first stock you'd like to highlight today.
Morton: The first stock I'd like to highlight is Imperial Tobacco (IMB). And the reason we like it, is the high quality cash flow that this company generates. The repeat business that this company gets. The pricing power that this company has got and also the very attractive dividend yield. Even though it has performed very well for us over last number of years, it’s still offering a prospective dividend yield of close to 4%. The company is committed to growing that dividend double digits for the next few years, and it has got very strong market positions in both the U.K. and Europe.
And on top of that they have obviously been a bit of a beneficiary from Brexit which has helped them because the profits that come from overseas, when you translate them back into sterling they have obviously benefited from that.
Wall: And before the camera started to roll we had a quick chat about tobacco stocks. Sin stocks, we talked about them last time you came in a few years ago. And we were just saying you cannot imagine another sector where more bad press and bad sentiment has been shocked at it over the last 10 years and yet it comes up smelling of roses.
Morton: I know, I mean, I think there are two reasons for that. First of all, it was priced very cheaply if you go back 10 years. So everyone was sort of really worried about this news flow that was coming their way. And in reality the companies have continued to do better than people probably thought they would. In other words, smokers tend to be quite sticky. I think the other thing is the pricing power these companies have got.
I mean if you look at what's happened to the price of a packet cigarettes, over almost any time period you want to mention over the last 10, 20 years. They have gone up significantly. So these companies even though they are seeing declines in the West in the number of smokers, they have been able to be more efficient and also put price increases through.
Wall: What's the second stock you'd like to highlight?
Morton: The second stock I'd like to talk about is Centrica (CNA). Centrica, is a utility business and this is one that actually hasn’t performed very well at all over the last few years. But I am getting more optimistic on the outlook for this company. There are two reasons for that, we've had a management change in the last 12 or 18 months.
There is a lot of restructuring going on. And Centrica as well know owns British Gas, so it's the largest supplier of gas and electricity in the U.K. That’s obviously been a pretty tough market for the last few years; a lot of pricing issues, lot of political issues. They've recently had an MMC report come out which has get a few remedies, with things I think which are fine for this – for Centrica.
The other thing which I think is a benefit is what we are seeing going on at the moment this year, we're seeing a large rise in the price of energy in terms of gas and electricity in sterling terms. So where there has been a lot of benefit for these small companies that have come into the supply market, they are going to find life much more difficult going forward and I think the Big Six [suppliers] if you like including Centrica are going to find themselves in a much stronger position in the energy market and they have been for some time.
Then the other part of the business is the E&P business and obviously that has been a pretty awful performer. They did a lot of investment when the oil price was much higher than it is now and in January the oil price got down to below $30 and things were looking pretty bleak.
The good news is that they have done lot of restructuring. They took a lot of cost out of that business. They've reduced CapEx and with the oil price now back over $50 and signs that OPEC might actually be talking to each other again. The outlook for oil looks a bit better.
So I think Centrica is quite an unloved stock at the moment it’s got a dividend yield of 5.5% which obviously is incredibly attractive in the current environment which looks well covered by free cash flow. They've got a pretty strong balance sheet, they raised some money earlier this year. So they have got a pretty strong balance sheet. So it's one that I have got high hopes for recovery from here.
Wall: And what's the third and final stock?
Morton: The third and final stock is Unilever (ULVR). This again is one of my long term favorites if you like. What I like about this business is long term compound growth that we get from the company. It's got fantastic exposure to emerging markets. We've had worries about emerging markets again over the last few years, but I am very much convinced of the longer term merits of being there; growing wealth, growing middle class population, more money to spend on Unilever's products.
But even in this difficult couple of years they have still managed to grow their top line at 3%, 4%, 5% which when you think about in one of the worst environments we've seen for currency devaluations, emerging markets, a very difficult European economy et cetera. To still be able to produce that sort of growth this to me, demonstrate the underlying strength of this business.
And it's those great things again about they've got products that people want to buy and are willing to pay a little bit more for. So they've got that pricing power. They have got a very good management team, who really have got handle of shareholder value and looking after their shareholder. And from a sterling investor's point of view and again we've got to take some credit from the devaluation of sterling because of Brexit it's still offering a prospective dividend yield of something like 3.2%. And if you think that Unilever's 10-year bond is yielding below 1% to me the equity looks pretty interesting.
Wall: Colin, thank you very much.
Morton: Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
