Laura Foll, co-manager of Lowland Investment Company explains why she is favouring industrials, banks, and consumer goods companies. Foll also gives her outlook for UK dividends in 2022, naming banks as a sector that could surprise on the upside through paying special dividends.
Kyle Caldwell, collectives editor at interactive investor: Hello, today I’m joined by Laura Foll, who is the co-manager of the Lowland Investment Company (LSE:LWI), Lowland invests in market leading businesses that are out of favour. The UK stock market has been out of favour for some time now, initially there was the Brexit uncertainty a couple of years ago, and then along came the COVID-19 pandemic, both those headwinds have been somewhat removed, but both domestic and international investors seem to be still shying away from the UK, why do you think that is, and what will the catalyst be for investors to increase exposure to UK equities?
Laura Foll, co-manager of Lowland Investment Company: It’s a great question, and one that I’ve thought about a lot, but probably one that I can’t give you a definitive answer for because it’s been a source of frustration for us, as much as many other UK investors. But I think what it really comes down to is performance, I think if the UK market were to significantly outperform, it would capture people’s attention. Now the problem with me saying that is that it is to a degree a vicious cycle, in that if you’re having withdrawals from the market, it’s hard to outperform in that withdrawal market, so you potentially need to see a period of stabilisation at least, in terms of flows before you get that outperformance.
I mean, what could drive that outperformance, we could see more takeover activity, we’ve certainly seen some takeover activity in the Lowland portfolio this year, and in the wider UK market as a whole. There have been a really broad range of takeovers, it’s not just been in the small company area, it’s been in some very large established companies as well. And I think that gives us, sometimes we can feel a bit like we’re talking into the void when we say that there is this UK valuation discount, but that takeover activity I think, lends credibility, and some evidence to that view that you can UK equities are trading at a substantial discount. And in our view, an unwarranted discount in some cases to global peer groups.
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Kyle: And as we head into 2022, what’s your outlook for the UK market, you just mentioned obviously, one of the opportunities is that it’s cheap compared to its own history, and compared to other international markets, is that the main opportunity, and what also are the risks?
Laura: I think the valuation backdrop definitely matters, context matters, we are starting from a point where this is this valuation discount in the UK, so that definitely makes me more comfortable with where we’re starting from. I also think that Lowland is an income fund, and we haven’t spoken much about dividends, but I think despite the very sharp falls that we saw in UK dividends in 2020, the UK dividend yield remains very attractive relative to other developed equity markets.
So we’re starting from a point where valuation looks quite low, and we also have a decent dividend yield compared to some other markets. So I think that’s a good place to start, and then if we think about the UK economy, more broadly, consumers are starting with a stronger balance sheet than they have done in quite a number of years. Yes, there are some headwinds to real wages because of inflation, but the consumer balance sheet is in, on average, quite a good place, obviously there are people that have been very badly hit by the pandemic, so averages can be a bit misleading.
But on an average basis that household balance sheet looks better. And I think we, barring unforeseen circumstances around lockdowns, etc., we should be heading to another year of decent economic growth, partly because we have a relatively easy comparative from the first half of this year. But we could be talking about economic growth in the UK of maybe 5%, 6% next year, which is a really decent backdrop to be starting from.
So I think there are always things that can catch you off guard in terms of lockdowns and that kind of thing, but I’m positive in terms of where we’re starting from in terms of the economic growth backdrop, and the valuation backdrop as well.
Kyle: And in regard to dividends, has the speed of the dividend recovery surprised you this year, and looking ahead to next year, are there any sectors where there’s potential for surprise in terms of those sectors recovering even more, and paying higher dividends than perhaps the market is forecasting at the moment?
Laura: Starting with 2021, I have been pleasantly surprised by the dividend recovery, we will probably, the year is not quite over yet, but we’re probably talking about dividend growth this year of in the 20s in terms of the percentage, that follows that roughly 40% fall last year. So we’re not getting back to 2019 levels, but a decent level of growth, nonetheless. And I think what’s particularly surprised me this year would be the scale of those dividends we saw from the miners.
I think a lot of people have been caught off guard by quite how large those special dividends were, and then also, the likes of Shell having cut its dividend two thirds last year, I definitely didn’t expect it to put up its quarterly dividend 40% this year, that kind of caught me off guard, and there will be the annualization benefit of that when we go into next year as well.
So when I think about next year, there’s quite a lot of conflicting factors to bear in mind, I think those mining dividends will likely come down, we’ve seen iron ore price fall quite a long way, and these mining companies have very strict dividend pay-out ratios, so if their earnings come down, then the dividends will likely follow. So we could have mining dividends potentially falling, we have that annualization effect from Shell (LSE:RDSB) the other way, and I think the other thing going back to banks, is that these banks, when they report earnings, they’re saying at the moment that they have excess capital, relative to what management think they should have.
So we could get some of that excess capital back in the likes of buybacks, but also special dividends, and I think that could potentially mean higher dividends from that sector than is necessarily an analyst forecast at the moment. So trying to being all of that together is quite complicated, but I think what it will likely mean in my – and this is just my view, that we could see further modest dividend growth in the UK next year, but I don’t think we’re going to be returning to 2019 levels. Because some of those rebasing, the likes of BP (LSE:BP.), they will not be going back to the dividends that they paid before.
Kyle: And at the start of a new year in 2022, are there any particular sectors that you would highlight that would potentially do well?
Laura: We’ve spoken about industrials, industrials is quite a material sector for Lowland, and one that we’ve been positive on for a long time because these are companies that, in order to exist, have had to become specialists, have had to generate – carve out a niche for themselves effectively, and niche allows them to make decent margins in a lot of cases. I think a number of our industrial companies I would say are also run by experienced management teams that over the course of the pandemic have really fine-tuned that cost base.
And I think we’ll see the evidence of that in the years to come, in terms of that margin number that they’re able to produce. So we’re certainly still happy with the industrials in the portfolio, it might be a bit of short-term pressure around margins because of costs, but we think it will be exactly that in short-term, and it will be able to be passed on in the future. I would say the other area that we are quite positive on at the moment, and we’re finding value in would be the consumer goods sector.
We have a position in Marks & Spencer (LSE:MKS) in the portfolio that’s a new position in the last year and a half or so, and actually, the evidence seems to suggest that consumers are still willing to go out and spend some of those excess savings that they built up. The M&S results have been good, you’ve had solid results from the likes of Halfords (LSE:HFD), the likes of Vertu Motors (LSE:VTU) are in the portfolio as well. And it just seems like consumers are willing to spend, and those results are coming in generally better than the market expects. So that’s another area that we’re finding quite a lot of value in at the moment.
Kyle: And in regard to the industrials, could you run through a couple of those in the sector that are the highest weightings in the Lowland Trust?
Laura: So some of the highest ratings within Lowland would be the likes of Morgan Advanced Materials (LSE:MGAM), which is a specialist materials manufacturer across a huge range of industries, but it would include transportation, healthcare, along with general industry, renewable energy. And this is a company where it’s a reasonably new management team, although having said that they’ve probably been there about five years now, that’s how much time has been compressed in my mind by the pandemic.
But they have, in my view, done a good job in terms of scaling back that cost base, reinvesting in R&D, reinvesting in sales and marketing, and our view is that that might lead to better organic growth in the future. Another of our bigger holdings within Lowland would be IMI (LSE:IMI), a very specialist engineering firm, makes valves, well often valves for critical industries for the likes of healthcare, for the likes of energy. And these valves, while often relatively small, are very critical to these production processes.
So you really – if one of these breaks, you absolutely want a new one because you don’t want your production process to stop because of it. So those are the types of really specialist manufacturing or industrial companies that we have in Lowland.
Kyle: And finally, do you have skin in the game?
Laura: I do indeed, and actually, me and James always declare what we hold in terms of our shares in all three of the trusts that we manage in the annual report, so if anyone wants to know how much we own of any of the trusts, it’s always there, and we update it every year. So I think it’s really important, quite a lot of my savings are in, not just Lowland, but all of the trusts that I manage. So I’m right there with the shareholders in terms of that.
Kyle: Laura, thank you for your time today.
Laura: Thanks very much, thanks for having me.
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