In our latest Insider Interview, fund manager Sue Noffke, head of UK equities at Schroders, names examples of shares that have been growing their dividends ahead of the high inflation backdrop over the past two years.
Noffke, manager of Schroder Income Growth (LSE:SCF), an investment trust, also names examples of companies that are offering jam today – in terms of a high dividend yield – and are also growing their dividend at a good pace.
Noffke tells ii’s Collectives Editor Kyle Caldwell how the right balance is struck between the investment trust delivering both growth and income, with a current yield of 5% on offer. Noffke also explains why, in terms of sectors she is favouring, consumer discretionary names trump consumer staples , and why she is confident the investment trust can continue its 28-year run of consecutive dividend increases.
Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Sue Noffke, manager of the Schroder Income Growth investment trust. Sue, thanks for coming in today.
Sue Noffke, manager of Schroder Income Growth investment trust: Delighted to be here.
Kyle Caldwell: To kick off, could you give us a run through of your investment process? The trust aims to deliver a rising level of income. So, how do you go about achieving that?
Sue Noffke: It’s very much a balance. It’s a blend. We call it a barbell. One of my colleagues has just written a piece with analogies to the Rugby World Cup and the set-up of forwards and backs. So, in terms of constructing a portfolio that delivers on those aims of an attractive level of income for investors, but particularly growing that dividend income to our shareholders and trying to do that in real terms, taking into account inflation, we need both those companies that have a high yield today, but maybe don’t grow that fast into the future, together with a set of companies that perhaps don’t yield as much today, but we expect to yield through that growth in the years to come. So, it’s jam today and jam tomorrow.
Kyle Caldwell: So, you invest in UK companies and you’re looking for companies that can grow their dividends ahead of inflation. Given that inflation has been at high levels for around two years now, have there been many companies achieving this? And could you name a couple of examples of companies that have been?
Sue Noffke: Surprisingly, yes. So, the last two years inflation has been high – higher than the 2% that central banks target. Round about 8.5% on a blended two-year average. But there have been a lot of companies, really diverse by sector and by size, who have managed to grow their dividends in double digits. I’ll give you some examples. So, oils, because the oil price has been high over the last two years. They’ve come in with 20%-plus dividend growth. Both Shell (LSE:SHEL) and BP (LSE:BP.), both are in the portfolio. Banks, particularly HSBC Holdings (LSE:HSBA) and Standard Chartered (LSE:STAN), which are Asian banks. They’ve been growing at 50% to almost 100% over the last year, and that’s because they benefit when interest rates go up, which is what we’ve seen.
Other companies in the consumer discretionary space. So, that is things like Whitbread (LSE:WTB), which is budget hotels, or Hollywood Bowl Group (LSE:BOWL), which is a leisure activity provider. They’ve been coming back from the Covid lockdowns and these are companies that really cemented their strengths: they’ve been gaining share, they offer great value for money for their customers, and we’ve seen the dividends come back really strongly. So, they doubled and tripled respectively, over the last 12 months. So quite exciting dividend growth. Not from everyone, but from a wide range of companies.
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Kyle Caldwell: Schroder Income Growth has a market-beating dividend yield of around 5%. So, how do you strike the right balance between delivering that level of income and also growing capital?
Sue Noffke: It’s the magic sauce of portfolio construction and it’s judgement. It’s knowing the companies. It’s not putting all your eggs in one basket. Clearly, there are higher risks with companies that are paying a high dividend yield. We try and look for ones that are mispriced and not value traps. So, ones where the dividend is sustainable. We do a lot of work to try and look at whether companies can finance that. What’s their balance sheet strength? What are the risks to the business model? What are the operating challenges that they face? And if we feel that the dividend is sustainable and those companies have a value opportunity, we will hold them in our portfolio.
But we also want to blend with those higher dividend yields of the future and to look for opportunities in that segment of the market. So, we try not to take too much style risk. We’re pretty style neutral. We go across the market-cap spectrum, so we’re not all in larger-cap stocks. We’ve got a lot in mid- and small-size companies as well. And we diversify the portfolio across a range of sectors. So, there aren’t many sectors that we have nothing in and that can be quite differentiated. We make sure that each holding counts, and we've got anything between 35 to 45 companies, we're about 42 at the moment. So, it is focused but diversified. And the secret is in blending those holdings to deliver for shareholders.
Kyle Caldwell: And could you name a couple of examples of high-yielding stocks in the portfolio today that presumably you're seeing a lot of value in, and [where] you think the dividends are sustainable going forward?
Sue Noffke: I'll start with a property company, and that's Assura (LSE:AGR). And you won't know it from walking around in the streets, but it does GP patient practices. So, the facilities for NHS healthcare, the tenant is effectively the government and we know that there is huge demand for healthcare services in the community. They've got round about 600 or so practices in the UK, [they have] got a lot of development opportunities as well.
Now property has come under pressure as interest rates have gone up, but Assura has been fleet of foot in terms of its financing. So, it's got a strong balance sheet and it's not exposed to the rising interest rates. It doesn't have refinancing really until towards the end of this decade and it locked in some of the lower-cost financing that was available in recent years. So, I think that one, which is yielding 8% with good prospects, it's growing its dividends sustainably at 5%. Not super-exciting, but good enough. That is a really good holding to have in our portfolio.
A different stock that would be yielding more than the market would be Legal & General (LSE:LGEN), and that is a household name. It also has some fantastic growth opportunities. It also has a strong balance sheet, and you can see the themes here. Their balance sheet comes under solvency too, which is a bit technical, but it's got strong solvency, a strong balance sheet, to cope with the amount of growth the higher interest rate is affording them.
Higher interest rates mean that a lot of companies are looking to outsource their pension liabilities to a third-party provider, and Legal & General has the capability, has heritage, of doing that really well. It's got the balance sheet to do that. It's yielding 9% in today's market. Again, it's growing its dividend by 5% per annum. We think that is sustainable. So, not only do you get the growth, but you can have jam today. So, I think those are two really attractive opportunities in the portfolio today.
Kyle Caldwell: In terms of sectors, you're overweight, which means you hold more than the index, in the consumer discretionary sector, but you are underweight consumer staples. Could you talk us through why the portfolio is positioned in that way?
Sue Noffke: A lot of it has to do with valuation and where we see the opportunities. So, where we're overweight in consumer discretionary, that's because the valuations have been attractive in the last year and still looking forward because people have been worried about consumer spending, about more domestic names.
And I've leant into that weakness in share prices to take advantage of the valuation opportunity, because I think these are high-quality businesses. A number of them are trading well. So, I've been very selective in which names and a lot of them we've already mentioned today. So, Whitbread in budget hotels, Hollywood Bowl, Pets at Home (LSE:PETS) would be another. These are really strong franchises that are taking share that consumers, even in a cost-of-living crisis, are prepared to open their wallets and spend there.
Now, there are a couple of companies in the consumer discretionary sector that aren't really consumer-facing, and they would be the professional services groups of RELX (LSE:REL), which does a lot of risk for insurance companies and Pearson (LSE:PSON), which is all about workforce skills and education. So, they're a little bit of an anomaly within that.
Now, on the other side, why am I not as heavily exposed to consumer staples companies is again [about] valuation. They have been quite richly valued, quite pricey for the level of growth that they've been delivering. Why have their valuations been quite high? Well, we've had a decade and a half of really low interest rates, and that's pushed these kind of more defensive, steady growers to very high levels. And I think there's a risk that that area has been under pressure. We've seen some of that unwinding go on in valuations in the last 12 months and so that's allowing us to start dipping our toe in, or putting these stocks on to the watch list. But I'm still less exposed than the market.
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Kyle Caldwell: And Schroder Income Growth has a remarkable dividend track record - 28 years in a row. How confident are you that will continue in the foreseeable future?
Sue Noffke: I'm really confident that can continue into the future. The great thing about investment trusts is that you can smooth your dividend payments to investors. So, in good times, you can hold a little bit back for the times [when] it's not sunny outside, it's raining and the wind's blowing, a bit like today.
What we have are really strong revenue reserves and we've been able to utilise those to help keep dividend growth going. Now, we've still got nine months equivalent of revenue reserves in our back pocket. So, we have huge confidence that no matter what the future holds, we can continue to grow our dividend to investors into the future.
Kyle Caldwell: Sue, thank you very much for your time.
Sue Noffke: Thank you.
Kyle Caldwell: That's it for this episode of our Insider Interview. Hope you enjoyed it. Please like, subscribe and comment, and hopefully I'll see you again.
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