Interactive Investor

Mark Slater: my outlook for dividends in 2022

22nd December 2021 21:33

Lee Wild from interactive investor

After a tough time for income seekers, star fund manager Mark Slater gives his view on dividend stocks and high yields, what he thinks will happen over the next year, and the cheap sector that now looks interesting. He also has some advice for those wanting to invest for income over the next 12 months.

Lee Wild, Head of Equity Strategy, interactive investor: Mark, the Slater Income Fund has generated attractive returns for you in 2021, could you just talk us through the highlights please?

Mark Slater, Chairman and Chief Investment Officer, Slater Investments: It’s been a good year so far, so the fund is up 21%, and the total return All-Share [index] is up 13%, so that’s a good position to be in at this stage in the year. The drivers have been fairly broad, a handful of names standout, I mean there are four companies which have contributed materially. River and Mercantile Group (LSE:RIV) is our top performer, that’s currently a bid situation, Liontrust Asset Management (LSE:LIO), which we actually own in growth and income [funds], has done very well for us. Sureserve Group (LSE:SUR), and the other one is Morgan Sindall Group (LSE:MGNS), those four stand out particularly, but there’s a whole lot of other companies that have done well.

Again, there are no large losers, which is a very important thing in terms of performance. So those are the dynamics, but we’re very happy with the fund's positioning, it’s got a really good yield now, the historic yield is 4.2%, and that compares with the trailing All-Share yield of about 3.1%. So very, very big yield premium, and we’ve been able to find very good capital growth opportunities as well.

Lee: OK, I mean things are looking up for income investors, and conditions continue to improve following the pandemic, what’s your outlook for dividends in 2022?

Mark: Well, I think the outlook for the fund is very much superior to the outlook for the market. But I agree with what you said, in that I think income has had a bit of a renaissance, thanks to COVID. The income sector was particularly hard hit during COVID, but what’s happened is a lot of companies have taken the opportunity to rebase their dividends. The company pay-outs were probably too high previously, dividend cover was around 1.5 times, it was at an historic low, and that’s jumped up to around 2 times now for the market overall, so the position is much healthier for companies in terms of their ability to grow their dividends.

It’s also probably the most unpopular part of the most unpopular developed market, the income space has been very unpopular for a long time. So the valuation setup is extremely attractive compared with the last five, six years. So I think it’s a really good starting point now, I think there’s good prospect for dividend growth, valuations are low. Now for the market overall, it’s slightly more complex because the market overall in the UK is dominated by 10 companies. Ten companies pay roughly half of all dividends. 

Now we have some exposure to some of those big 10, but our exposure is pretty small, only 13% of our fund is invested in the big 10 dividend payers, and some of them are going to be paying lower dividends in 2022 than they were paying in 21. The mining complex is responsible for a quarter of all dividends in 2021, and those companies, or some of those companies, are going to be paying less because the Rio Tinto's (LSE:RIO) of this world pay, they no longer have a progressive yield, they just pay a proportion of their profits. And they had super normal profits this year, that’s not – it’s very unlikely they’ll be in the same position next year.

BHP Group (LSE:BHP) is leaving the UK market in the second half of 2022, it’s going to Australia, so those are falling out. You’ve got companies like GlaxoSmithKline (LSE:GSK), which have also changed their dividend policies, they’re going to pay less. So the market overall is so dominated by these big companies, and there will be some challenges. For us, I see us growing our dividend quite happily, so it’s going to be a slightly nuanced picture I think in 2022.

Lee: Well, you’ve partly answered my next question. I was going to say, are there any companies or sectors where you think dividends are at risk in the months ahead, or do you expect further rebasing of dividends?

Mark: I think mining is a bit of a special category because they just pay out a proportion of profit, they got in trouble by trying to pay out rising dividends, so they’ve changed the way they do things. The offset that could, at the kind of macro level, the offset that you could see could be from banks, they could start to compensate for the lower mining dividends. But it’s more likely I think, that investors will ask banks to do buybacks, as opposed to increased dividends. So that’s probably not going to happen.

So it’s difficult to know, but again, our focus is much more on individual companies, and we have the luxury of not having to own these very, very big companies in a big way. You know, 90% of the opportunity set for us is outside the FTSE 100, and there are some really interesting companies of all shapes and sizes that are paying great yields, and they’re growing them, so that’s our focus.

Lee: I mean there are lots of eyewatering dividend yields on offer in the FTSE 350 index, especially among the miners, which you’ve talked about, and the insurers and the housebuilders. Why don’t you have greater exposure to some of these very generous payers?

Mark: Well, we have a fair bit, in mining we’re underweight. We don’t think in terms of underweight and overweight, but we would technically be underweight, we have about 5.5% of the fund in miners. And we were big shareholders in Rio Tinto at one point, but it’s now only 1.5% position. We have a bigger holding in Glencore (LSE:GLEN), which is not everybody’s cup of tea, but it’s dynamics I think are much more interesting than Rio Tinto. Rio Tinto is all about iron ore, whereas Glencore is all about copper and cobalt, which is significantly more interesting, I think. 

So we have some exposure to that sector, but not as much as others. Insurance we have a big exposure to, we have about 15% of the portfolio in insurance of all kinds, and there are some very attractive payers, as you say, in that space. In housebuilding we have minimal exposure, it was an area we had a bigger exposure to before, but we’ve reduced it over time. But prices have gone down, have come down quite a bit so it is becoming more interesting in that space.

Lee: Do you have any advice for income investors for the next 12 months, what should they be looking at before committing cash to a particular company?

Mark: I think it’s just the usual things, valuation is key, if you get valuation wrong, you’re not going to make money, irrespective of the yield you’re not going to make money. Earnings growth, cash flow, dividend cover, all of those things matter hugely. In the end the company paying a dividend is just a company that needs to generate cash like any other, so I would just stick to the basics. I don’t think there’s any – there’s no other way, I think one has to be very, very focused on fundamental value. And not try and be too clever, normally it’s fairly obvious if a company is in a good position to pay a rising dividend over time, and if it’s not obvious, then I would avoid it.

Lee: And don’t be blinded by high yields?

Mark: No, I think high yields – I mean sometimes they’re paid, but I think very high yields are high for a reason, almost always, except when you get extreme markets. I think when you get a very savage correction in markets, then high yields can be very attractive, and they can be anonymous, but most of the time a high yield will be attached to a company that’s not going to growing its earnings or dividends very much. So – or they’re quirkish, in that the companies can be effectively returning capital, which is not the same thing as a sustainable operating yield. 

So I’d be wary of high yields, but I do think the sweet spot has moved in a favourable way. So you go back a few years, from about 2015 until pre-COVID, so 2019, it was pretty difficult to find a decent business with a yield with a four in front of it. And now there are lots and lots of them, so I think the opportunity set has significantly improved, and in large part that’s thanks to COVID. 

Lee: Mark Slater, thank you very much for joining me today.

Mark: Thanks Lee, very much.

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