Fund manager June commentary – Lowland Investment Company

UK equity markets continued to modestly recover during June from their lows in mid March. Within this the shift in market leadership that we saw during May largely continued, with cyclical sectors such as industrials, financials and materials broadly performing well, while defensive sectors such as healthcare underperformed. For the Lowland portfolio this meant that the large position within the industrials and financials sectors positively contributed to performance during the month, having been detractors from performance calendar year to date. The strong share price performance within cyclical sectors in our view reflects better than expected economic data including gauges of industrial output and US employment numbers as economies begin to recover.

At the stock level among the strongest performers in Lowland were two of the industrial companies held; Morgan Advanced Materials and XP Power. Both reported trading updates that were encouraging. In the case of XP Power the strong orders within their healthcare and semiconductor-exposed businesses offset weakness in their industrial order book. In the case of Morgan Advanced Materials, they have a business that is more exposed to general industrial activity therefore during April and May organic sales were down in the region of 20%. However, the company went into the downturn with a strong balance sheet and are taking the opportunity to reduce their cost base.

The largest detractor at the stock level during the month was UK bowling operator Ten Entertainment. This fell on the news that the Chief Executive is resigning to take up a role at a larger company. While this is disappointing, the balance sheet is in a resilient position with them having raised equity towards the beginning of ‘lockdown’ and in our view there will continue to be good demand for their value family entertainment offering.

During the month we added to existing holdings including Hipgnosis Songs Fund, Tesco, K3 Capital, STV and Alpha Financial Markets Consulting. There was also a new position established in Jadestone Energy. These purchases are a deliberately diversified mix; some such as Tesco and Hipgnosis are continuing to pay dividends (both have a forecasted over 4% dividend yield), while others such as STV and Alpha Financial Markets Consulting have temporarily suspended their dividends but we hope both will represent a good total return opportunity for shareholders. Sales during the month included selling a small position in housebuilder Taylor Wimpey, which had recovered well from its lows, and reducing positions including HICL Infrastructure and XP Power as in our view there were better total return opportunities elsewhere.

2020 will undoubtedly be a very difficult year for dividend income, with UK dividends in aggregate forecast to fall in the region of 40% (note that is not a portfolio forecast – it is for the whole of the UK market). It is now clear which sectors will not be paying dividends in the short term – this includes the majority of retailers, industrials, housebuilders, non-life insurers and banks. The bigger question now that the short-term outlook is clearer is when and at what level dividend payments will resume. Here there is some disagreement, with consensus analyst forecasts assuming a rebound in dividends in 2021 while dividend futures imply a further decline. In our view UK dividends are likely to grow modestly in 2021, but not reach levels seen in 2019. Our view that dividends will grow again in 2021 is for a number of reasons. Firstly some management teams have made clear their desire to return to paying a dividend as soon as is feasible, or have laid out a clear timeline. Secondly because there are many companies paying no dividend in calendar year 2020, if they return to paying even a small dividend this will have a material effect on dividend growth in 2021 (particularly for larger companies in the index such as the banks).

A positive that may result from this period of material dividend cuts is that income generation in the UK is likely to become more balanced; while historically UK income generation was heavily dependent on a few key income payers including Royal Dutch Shell and HSBC, this is likely to be different in future (Shell has already rebased its dividend by two thirds, HSBC may take the opportunity to lower their payout ratio). While this will mean starting from a lower dividend yield, it could lead to better diversified and more sustainable dividend payments in future from the UK market.

Glossary

Dividend:  A payment made by a company to its shareholders. The amount is variable, and is paid as a portion of the company’s profits.