Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Rachel Winter. She is Investment Director at Killik & Co. Hello.
Rachel Winter: Hi, Holly.
Black: So, we've got a bit of an income flavor to our three stock picks this month. All dividend paying stocks. Where should we start?
Winter: Well, it's been a difficult year for income investors. A lot of the highest dividend payers have historically been in the oil and banking sectors in the U.K., and it's been a difficult year for those companies because of the pandemic and lots of these companies have had to cut their dividends. But it does feel that things are now starting to turn around because of the success in the vaccine rollout. So, let's have a look at a couple of these companies.
Let's start with Lloyds Banking Group (LLOY), which is the biggest retail bank in the U.K. Lloyds has had to cut its dividend because of what the regulator said. The regulator has banned U.K. retail banks from paying dividends. But we do expect Lloyds Banking Group's dividend to return to over 5% by the year 2022. So, it's potentially worth a look for income investors. Lloyds, as I said, is the biggest retail bank in the U.K. It has limited exposure to overseas operations and also to investment banking. So, that makes it relatively low risk in comparison to some other banks. And what we also like about Lloyds is its investment in digital capabilities. So, a lot of people have concerns about customers moving away from traditional banks to other online only banks such as Monzo. But actually, Lloyds is currently the biggest digital bank in the U.K. with over 17 million digital users. So, we have a lot of confidence in Lloyds progress in that particular space.
Black: Okay. What is our second dividend paying stock?
Winter: Second one is BP (BP), the oil company. And clearly, again, oil has been a very difficult sector over the last year. Oil is predominantly used for transport and clearly, with lockdown no one's been allowed to travel anywhere. Therefore, demand for oil has fallen and that had a big impact on the price. But with lockdown lifting, we're starting to see demand for oil rising again. So, over the last year, the oil price has risen from below $20 a barrel to over $60 per barrel. So, we are starting to see oil companies such as BP becoming very profitable once again. So, BP did have to cut its dividend last year, but it cut it from a very high level. So, even with the cut BP's dividend is still over 5%, so very attractive compared to what you can get elsewhere on the markets. And what we also like about BP is the move towards renewables. So, BP historically has been very much a fossil fuel company and it's now moving away from that to become an energy company with a big focus on renewables. And so, to put that into context, in 2019, BP hoped to generate about 2.5 gigawatts of power from renewables, and by 2030 it hopes for that to be 50 gigawatts. So, that just gives you a taste of the extent of BP's ambitions in the renewable space.
Black: Okay. And what is our final stock today?
Winter: The final one is called American Water Works (AWK). This is a company without a massively high dividend at the moment. It's currently about 1.5%. So, it's still higher than what you can get in a cash account. But what we like here is that the dividend is very much growing. So, American Water Works is, as the name suggests, it's an American company. It's a water utility. So, it's allowed to make what's called a regulated amount of return on the value of its regulated asset base. So, that's the value of the pipes and its water treatment companies and projects that it owns. The water utility network in the U.S. is currently very fragmented and American Water Works is managing to grow quite quickly by acquiring lots of different fragments, and it's doing this very successfully. So, we do expect the company to be much bigger in future.
And we do believe there is a real need for the U.S. to invest in its water infrastructure. So, for example, if we look at the Texas water crisis that happened back in February, millions of homes were left without water because of the aging state of the Texas water infrastructure. We also know that Joe Biden wants to spend a huge amount of money on upgrading infrastructure in the U.S. and hopefully, some of that will find its way into the water sector.
Black: And I think it's a really good point that it's not just about the high headline yield when we're talking about income investing. It's about a stock's ability to keep growing there, and that's good because it keeps up with inflation.
Winter: Absolutely. And just one more thing about American Water Works. We do find that often these utility companies are treated very much like bonds. And in the bond market sell-off that we've seen recently, we have seen the share prices of some of these utility stocks falling as well, and therefore, you could argue that now it looks to be quite an attractive entry point.
Black: Rachel, thank you so much for your time. For Morningstar, I'm Holly Black.
