James Gard: Welcome to Morningstar. I'm delighted to be joined by Michael Field again. This time, we're going to be talking about European income opportunities. So, what's going on at the moment, Michael?
Michael Field: Well, I think the last few weeks have been very dominated by the macro. We've been hearing nothing but central bank interest rate decisions. You had the ECB cutting rates for the first time last week. And then over the next couple of weeks, we've got the Bank of England and the Fed decisions too. So that's really been dominating the conversation, I would say.
Gard: So how does that affect the outlook for income investors?
Field: So, I think for income investors, they've been relying on and shifting towards, to some degree, bonds, be they government bonds or corporate bonds over the last few years, as yields soared and those investments offered a very attractive income stream. But as interest rates are starting to fall, and the markets are pricing that in and bond yields are already falling, as we've seen across the board, income investors are kind of back to the table again, looking for opportunities, which really opens the door for equity investments in Europe.
Gard: Definitely. So, you've been scouring the income universe for us. You created a dividend screen. What have you found?
Field: So surprisingly, if you will, that there's been a whole host of dividend opportunities still available in Europe, which we've looked across the board really, and we've broken it down to some of the really high yielding stocks and kind of worked our way down the list from there, looking at which names are actually sustainable, which names are actually going to be paying those high levels of dividends, not just this year, but two and three and four years into the future. And we kind of broadly broke that down into two brackets, one of which is banking stocks, which we saw a few very attractive names offering very high yields. And then the other is the consumer space, which we've kind of found a broad selection of stocks across different areas of the consumer space that again are offering really attractive yields and as I mentioned, sustainable being the keyword.
Gard: So, these are undervalued stocks. But what else is special about them?
Field: So, you said it undervalued, all five of the stocks that we pulled up are 5-Star stocks at the moment. So, they're kind of screaming buys from that perspective. But what's interesting about the two brackets as well, if you'll notice, so banking and consumers, those are two sectors that are going to be heavily influenced to some degree by interest rate cuts. And that could be a factor in why we see stocks that are so cheap at the moment in those segments and why they're offering such high yields.
Gard: So, banking stocks are kind of as a bit of a contrarian play at the moment. But should we crack on and talk about your two picks in the sector?
Field: Yeah, indeed. Indeed. So, I think people are concerned again, that interest rates fall and the profitability for these kinds of stocks is affected as a result. But the names that we found – so Lloyds (LLOY) in the UK very much a household name, very much a strong retail operation in the UK, strong cash flows that can cover those dividends. And then the other side is Handelsbanken (SHB A), the Swedish banking stock, which has a heavy presence in Sweden, which kind of underlines the profitability there. But even if you look at their other operations as well in Europe, generally speaking, we would say it's probably one of the best run banks that we cover.
Gard: Let's talk about consumer stocks now. So, these are interest rate-sensitive stocks as well, right?
Field: Indeed. To a second derivative, if you will, the obvious candidates for sectors that are going to be affected by interest rate cuts are the likes of utilities and banks, et cetera. But also, consumer is an area that as interest rates fall and mortgage rates fall, we believe that will kind of take the burden off consumers, add a few more pounds or euros to their wallet every month and potentially allow greater level of discretionary going forward. So, there's a number of names in the consumer sector that we think are quite interesting from there.
You've got Reckitt Benckiser (RKT), so the consumer giant that people might not be familiar with the name outright, but they certainly be familiar with some of the brands that fall under Reckitt's remit, so everything from Durex to Cillit Bang, to baby formula as well, which there's some current legal issues with, but we think they've been over egged, and that's why the stock is trading at such a large discount and offers such a strong and attractive yield as a result of that.
The second one then is Kering (KER), the French luxury consumer brand, which is the owner – again, it's a name that perhaps everyone is not familiar with, but they're certainly familiar with the brands that they own, the likes of Gucci, which generates quite a large proportion of income for this stock. Again, luxury goods had a really good two years. It's been falling off in the last year. So, the luxury market has got a bit more difficult, but we think those resilient, strong brands like Gucci are going to last.
Gard: And what's your final stock then, Michael?
Field: So, I was going to building up the suspense there. Yeah, the final stock is Imperial Brands (IMB). So probably not one for the ESG portfolios, but they're the manufacturers of cigarettes and vapes, et cetera. Cigarette companies, obviously, they're not very much liked at the moment and the stock itself has been beaten up, along with British American Tobacco (BATS), the other giant into the tobacco industry in the UK. But at this stage, the stocks are offering such high yields that are completely covered by cash flow that they're too good and attractive an opportunity to ignore at this point, I would say.
Gard: Yeah, tobacco companies are unusual one in that if you remove an ESG screen, they're very attractive companies for the time being certainly. British American Tobacco fits in that category as well, highly undervalued, big yield, chunky cash flow and low debt.
Field: Perfect for an income investor.
Gard: Brilliant. Well, thanks so much for your time today, Michael. And let's catch up in a few weeks.
