Holly Black: Welcome to the Morningstar series, "3 Stock Picks." I'm Holly Black. With me today is Rachel Winter, Investment Director at Killik & Co. Hello.
Rachel Winter: Hi, Holly.
Black: So, we're talking about three stocks today but with a bit of a difference?
Winter: We are. So, I think as an industry, we are quite often criticised because we're very good at giving buy ideas but we're not so good at saying when you should sell a stock. So, today, I'm going to talk about three stocks that we don't like at the moment.
Black: Okay. So, where are we starting?
Winter: So, the first one is a big name. It's GlaxoSmithKline. So, this is a very popular stock. It's very widely held. People love this stock for the income. But ever since Vodafone cut its dividends so much a few weeks ago, we've been having a look at some of these big dividend payers in the FTSE and just thinking about how sustainable some of those dividends are. So, GlaxoSmithKline, it pays a dividend of about 5.1%. But in recent years, it hasn't been able to afford that dividend from its current earnings. It's had to top up that dividend from earnings from previous years and that's just not sustainable over the longer term. Furthermore, this year, Glaxo is making an acquisition worth £4 billion, but it's also paying out £4 billion in dividends. So, it's making that acquisition, it's taking on debt on which it has to pay interest and yes, it's still paying out that massive dividend. So, as investors we just don't think that makes sense.
Black: So, you say it is quite difficult to find stocks that people are openly negative about. What does it take for you to put a sell rating on something?
Winter: We're just looking for companies that aren't growing. So, within our portfolios we just want to have companies that are in sectors that have potential for long-term growth. So, if we can see a company that just doesn't have potential to grow its top line, to grow its revenue, then we prefer not to be invested in that company. We'd rather sell and buy something that's got more potential.
Black: Okay. So, the second sell stock?
Winter: Second one is Direct Line, which is one of the leading general insurers in the UK This has got a dividend of over 8%. So, you should look at that and think, you know, why is that so high. And for me, that really just makes the alarm bells ring. It's a very high dividend that the company can only just afford to cover. So, any sort of negative shock there is going to make that dividend quite difficult to pay. And actually, back in September, we did have a negative shock. So, the industry has been criticised by the Citizens Advice Bureau and they've actually raised what's called as super complains with the Financial Conduct Authority and it's all about these so-called loyalty penalties. So, they are finding that within the insurance sector customers that are very loyal and stay with the same provider are being charged a lot more than customers who are brand new. So, the insurance companies are raising the premiums of their loyal customers every year and offering new customers these really great deals. So, the example the FCA gave was that for home insurance customers who have been with their insurer for five years are paying 70% more than new customers. It's not fair. It's probably going to have to change and that could hit the profits of the insurance industry.
Black: So, I think, what's fascinating to me about buy and sell ratings as well is that you could have a really negative view on a stock and the next person that walks in here could be saying, buy it. So, how can that change so much?
Winter: I think it just shows that no one really knows for sure. Everyone has got their own view. And it also depends why you are investing. So, if you are someone who really, really, really needs that income, then perhaps you would be willing to take a bit more risk on a high-yielding stock, but we would prefer to invest in a company with a much lower dividend where that dividend has potential to grow and where someone needs money from the portfolio, we'd probably rather take some of that from capital than take it all out of a high dividend.
Black: Okay. And what's the final one we're talking about today?
Winter: The final one is called Ferguson. It used to be called Wolseley. So, this is a UK-listed supplier of heating and plumbing supplies and also building materials. So, while it's listed in the U.K., about 60% of revenues come from the US and it's kind of positioned itself towards the repair and maintenance market. And actually, in the US, that is a market where we are seeing declining levels of growth. And that led Ferguson to issue a profit warning earlier this year and we just don't think that there is growth there. We think that growth is going to start declining and it's just not a company that we want to invest in anymore. So, we've issued a sell rating on that.
Black: And once you issue a sell rating, is that company kind of out for good? Or is that something you will revisit and reevaluate?
Winter: It's something we will keep an eye on. With Ferguson, I think, the repair and maintenance market probably is at the start of a bit of a decline. So, I would say, it's probably very unlikely that it gets back onto the buy list in the near future unless the stock really falls a huge amount and we think it becomes very oversold. So, unlikely to come back on the buy list, but you can never say never.
Black: Thank you for your time.
Winter: You're welcome.
Black: And thanks for joining us.
