Each week. a professional investor tells MoneyWeek where he’d put his money now. This week: Simon Callow,assistant fund manager, Midas Income & Growth Trust Plc.
With Britain, America and western Europe effectively in recession, it is clear that the credit crunch has dealt a severe blow to corporate cash flow and firms’ ability to pay dividends. And the huge contraction in lending, instigated by cash-strapped banks, has turned attention to the immediate balance-sheet strength of their corporate clients. In the wake of high-profile dividend suspensions by familiar names such as Carnival, Mitchells & Butler and Punch Taverns, investors are realising that dividend payments can no longer be taken for granted. It’s a similar story across the pond, where US dividends are reported to be disappearing at their fastest rate in 50 years. The re-emergence of rights issues as a way of raising emergency cash from shareholders provides additional evidence of balance-sheet fragility.
Investors should be wary of firms with significant debt rolling over in 2009 and 2010. Debt re-negotiation with creditors can become an unwelcome distraction for management, just at the wrong time. It can also prove costly to shareholders, if the result is a significant increase in a firm’s cost of borrowing.
So how can investors navigate this quagmire? Monitor when a firm’s debt matures, plus its free cash flow, interest cover and, by implication, ability to pay dividends. In a low interest-rate world, a safe dividend yield, above the yield on government bonds, will become increasingly attractive. The view that turnover is vanity, profit is sanity and cash is reality has never been more appropriate. So high yielding, strongly cash-covered international firms have significant investment merits going forward. In this increasingly unforgiving investment environment, there’s no shame in keeping an investment strategy simple. Our favoured stocks are Vodafone, BP and GlaxoSmithKline.
Vodafone’s (LSE:VOD) business offers low cyclicality in terms of demand for its products and is therefore relatively defensive. Furthermore, the new CEO wants to extract value from the company’s existing businesses, signalling a move away from the previous growth strategy based on acquisitions. The group’s operating expenses are to be cut by £1bn by 2011, which bodes well for future shareholder returns. Vodafone offers a high, secure dividend yield of 6%, that is adequately covered by its current and forecast cash flows.
BP (LSE:BP), meanwhile, is reaping the benefits of a record high crude oil price and its renewed war on operational costs. The company’s relatively new CEO has instigated a stringent cost-cutting exercise across this integrated oil major, which is showing early signs of succeeding. The company’s strong cash flow and ability to reduce short-term capital expenditure remain attractive. It is worth remembering that BP last cut its dividend in 1992. Since then the firm has earned a reputation for prudent dividend management. BP yields 6%.
Glaxosmithkline (LSE:GSK), the pharmaceutical manufacturer, is another stock that enjoys a strong balance sheet. Sales of the company’s leading asthma, vaccine and antibiotic products, together with those from its over-the-counter consumer health products, firmly underpin the group’s formidable cash flow. Another strength is its sizeable overseas turnover. This helps to shield profits from sterling’s recent weakness. The yield is 5%.
| The stocks Simon Callow likes | |||
|---|---|---|---|
| 12-month high | 12-month low | Now | |
| Vodafone | 193.8p | 96.4p | 140.85p |
| BP | 657.25p | 370p | 488p |
| GlaxoSmithKline | 1,403p | 986p | 1,285p |