Income Portfolio

Commenting on a post here Matt asked whether I would post details of my portfolios.  So here is a brief look at my Income Portfolio, with some comments and pretty pictures:




Click on chart to enlarge

This pie chart shows the split of my Income portfolio by the stocks that I hold.  Looked at another way by sector holding (thanks to Stockopedia for this):

Click on chart to enlarge

I am overweight the market in Industrials (BA.; PAY; IMI; HLMA; FENR) and Consumer Defensives (ULVR; RB.; TSCO; GRG).

 The table below shows a short profile of each investment:

Click on table to enlarge

The definitions of the columns are:

Fwd Yield on MV - Is the expected yield over the next 12 months based on the current share price.
Fwd Yield on cost - Is the expected yield over the next 12 months based on my average cost of purchase.
5 year Div CAGR - Is the compound annual growth rate of the dividend per share over the last 5 years.
Fwd earnings yield - Is the expected EPS over a rolling 12 months divided by the SP (the reciprocal of the P/E ratio).
3yr Div % of FCF -  This takes the last 3 years of dividends per share and shows it as a percentage of the last 3 years of free cash flow.  Important to do this over a reasonable cycle as one year's FCF can be misleading.
ROE - Reported earnings divided by the average equity ([opening and closing]/2).
P/BV - The share price divided by the book value.
Original purchase yr - The year in which the first purchase was made.  There may be purchases or sales in subsequent years.
TSR - Is total shareholder return (dividends not reinvested, I have to live off something :-)) and is calculated using the excel function XIRR allowing for the timing of cash flows associated with the investment to produce an annualised return.
  
I have highlighted in orange areas of concern or weakness: 

I view a current yield below 3% as a weakness, although companies such as Compass with a 5 year growth rate of 15.6% pa and a TSR of almost 25% pa compensate for this weakness.

Shell is the biggest disappointment for dividend growth, although it does have one of the highest yields.  The 3 yr Div % of FCF explains why this might be, although they have a good return on capital employed of around 25% (although this appears to be reducing in the past few quarters) and a low weighted average cost of capital (WACC) of 8.8%, they have a propensity to chase a large number of high demand capital expenditure projects that suck up a substantial amount of their FCF.

Of the other companies that appear to have a high percentage of 3 yr Div % of FCF are companies that are going through a period of change and likely to cut back on capital expenditure i.e. Vodafone (future sale of Verizon Wireless); Tesco (reduction in large scale super/hypermarket development); Greggs (cut back in new shop openings); Bhp Billiton (declared aim to reduce capital expenditure and increase returns to shareholders); Merose Industries (is somewhat like a private equity house and a recent disposal will change the profile).

The companies with recent low returns on equity are all due to exceptional costs being incurred during the year.  How exceptional these are can be seen by a quick look at the 5 year average for ROE, only ICAP and Tesco are in double digit returns with returns of 12.5% and 15.7% respectively.

GlaxoSmithKline has a very high P/BV, due to the book value being savaged by legal costs, penalties and write downs (I'm expecting more of this from China), this also accounts for the very high ROE.  Over 70% of their business is financed by debt, so consequently they have the lowest WACC.

Tesco and Greggs disappoint on the TSR, but I am expecting substantial changes over the next few years.

Over the past 5 years to 31 December 2012 the dividend income from my income portfolio has grown by a CAGR of 13.4% pa. which also includes numerous special dividends.  I'm not certain of replicating this every year, but at this rate it would double every 5.5 years.

My current portfolio has a weighted average forward yield of 3.8% and a forward earnings yield of 7.2% (i.e. expected to cover dividends 1.9x), with earnings expected to grow by about 8%.

Dialight IMS

Supplier of light emitting diode (LED) solutions for industrial users. Applying leading edge LED technology, it produces retro-fittable lighting fixtures designed specifically for hazardous locations, obstruction signals and traffic signalling.  I have a holding in my growth portfolio(epic code: DIA). 

Dialight issued an interim management statement today that essentially confirmed expectations of underlying profit for 2013 in line with last year.

Other new points of note are that the Industrial Lighting business grew by just under 60% for the 10 months and they are on target to increase the sales force of the Industrial Lighting business from 59 at the end of last year to 100 by December 2013.  They have consumed £10.2m of cash since the interim stage, which is due to additional inventory levels that they state will be reduced by the year-end.

They make a comment in the final paragraph of the statement which states "...As ever the precise timing of Industrial Lighting orders remains difficult to predict..." which is rather different to the statement at the half-year stage which was also repeated in their September trading statement of "...The timing of the award of major Obstruction system contracts remains difficult to predict...".  I may be reading too much into the change of language and it is probably a slip, but caused me a moments thought that they were concerned about order intake over the last couple of months for both Signals (with current lower order intake)  & Lighting. 

BAE Systems MOD agreement

A global defence, aerospace and security company. BAE Systems delivers a range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and support services.  I have a holding in my income portfolio (epic code: BA.)

 

Yesterday BAE issued the outline of an agreement with UK MOD on rationalisation of the UK ship business.  This will result in the closure of the Portsmouth shipbuilding facility with the loss of 940 jobs and to consolidate shipbuilding in its Scottish facilities, although this will also result in the loss of a further 835 jobs.

The cost of the restructuring will be borne by the MOD.

Idox trading update

The Company is engaged in the development and supply of software solutions and services to the United Kingdom public sector and asset intensive industries worldwide. It operates in four segments: Public Sector Software, which delivers software service solutions to mainly local government customers across a broad range of departments; Engineering Information Management, which delivers engineering document management and control solutions to asset intensive industry sectors; Information Solutions, which delivers both an information service and consultancy services to a diverse range of customers across both private and public sectors and Recruitment, engaged in providing personnel with information, knowledge, records and content management to a diverse range of customers. It also provides information management, Web development, online publishing and training services. I have a holding in my growth portfolio (epic code: IDOX)

 

Idox announced a trading update today following the closing of their year-end.  They state that despite a stronger second half to the year they will fall short of their May 2013 EBITDA guidance for the full year by up to 20%.  So I make that £14.4m compared to £16.7m last year.  To be so far off their £18m guidance in May, the directors should have known well before today that there would be a material change in their trading performance compared to their own guidance, in which case they had a duty to announce immediately and not wait until a regular announcement.  This implies they were not aware of such a material shortfall until after the year-end.

The main cause of the decline, is still the Engineering Information Management division which historically has been 31% of group sales.

The management state they have carried out an internal review to identify areas in need of improvement and are in the process of taking remedial action. They also stated that they will appoint a new Chief Financial Officer shortly, the previous one left at the end of October having resigned in mid-August.

This is an awful outcome from a company that appears to have taken it's "eye off the ball", with EBITDA falling from an expected £21m at the beginning of their financial year to £18m by May and ends the year at an expected £14.4m.  Any new CFO is going to want to make sure that there is no repeat of this and may insist on more radical actions and provisioning.  I will seek to cut my losses on this share over the coming weeks. 

Dialight new purchase

Supplier of light emitting diode (LED) solutions for industrial users. Applying leading edge LED technology, it produces retro-fittable lighting fixtures designed specifically for hazardous locations, obstruction signals and traffic signalling.  I have a holding in my growth portfolio(epic code: DIA). 

I initially covered Dialight here as a growth portfolio candidate and here a day later on 22 July when they announced their interims.  At the interim stage although they produced good growth in the lighting division of 70% there were problems with the Obstruction part of the signals division where sales declined by 40%.  There was a further announcement on 12 September stating that due to continued delays in the placing of orders for Obstruction Systems, they expect the results for 2013 to be similar to 2012, for which I'm assuming to mean 40.7p (diluted EPS for the continuing businesses).

Following the profit warning on 12 September the SP declined by over 16% to 1150p and although it recovered a little over the next couple of weeks, I managed to pick up some shares last week for 1090p. 

The expectation is that the issues with Obstruction Systems are expected to be of a short term nature, they stated at the time of their interims that they were in negotiations with 5 US customers with a total potential of 27,000 towers, I reckon that should eventually represent $77m worth of business.  By their very nature the order receipts for the Obstruction Systems business addressing cell phone and broadcasting towers will be lumpy.  This market in the US is expected to be worth about $400m.

The expectations are for a return to growth in 2014 with consensus at about 60p EPS, with continued strong growth in the Lighting Division and the Signals Division seeing the likely result of the successful conclusion of some of those US orders. 

In a recent report on the LED sector by Edison they state that data from McKinsey expects a CAGR of 47% pa. during the period 2012-16 for the LED Industrial lighting sector.  The problem that Dialight clearly have, is managing the lumpy order intake from the Obstruction Systems business alongside the fast growing Lighting Division.

Royal Dutch Shell 3rd qtr results

Royal Dutch Shell a global group of energy and petrochemical companies. I have a holding in my income portfolio (epic code: RDSB).

Shell announced their third quarter results today and they made for disappointing reading.

Third quarter sales were $116.5bn up 3.9% although earnings, on a CCS basis, were $4.2bn showing a decline of 32%.  Earnings in the quarter were affected by a number of issues:

• significantly weaker industry refining conditions resulting in lower margins,

• increased Upstream operating expenses and exploration expenses,

• production volume reductions from maintenance and asset replacement activities,

• the impact of the challenging operating environment in Nigeria and

• lower dividends from an LNG venture.

Sales for the nine months were $342bn down 2% with earnings on a CCS basis of $14.6bn down 26.3%.  Reported earnings for the nine months were $14.6bn down 27% and EPS $2.32 down 27%.

A dividend of $0.45 was declared an increase of 4.7% over last year and amounts to $1.33 for the nine months.  The Sterling equivalent of the $0.45 will be announced on 6 December and paid on 23 December (xd 13 November).   

Production in the third quarter was down 4% from the second quarter and showed a 1% decline in the nine months compared to last year. 

Net debt was $22.8bn an increase of $3.6bn from the year end and gearing increased from 10.2% at the year end to 12.7%.  FCF of $8.3bn ($13.3bn LY) was insufficient to pay for the dividend and share repurchases totalling $9.6bn.

This was a weak performance from Shell and follows uninspiring results at the interims.  Shell need to consider rationing their capital expenditure that was already running well in excess of $30bn, but is now expected to top $45bn for this year, up from around $25bn just a couple of years ago.  Some of these investments have been poor value and continue to erode equity with write-offs due to asset impairments ($234m written-off this quarter).

Reducing capital expenditure to below $30bn and using the capacity in the balance sheet (gearing currently 12.7%), would allow for a meaningful return of cash to shareholders.  It is not often that I push for substantial share repurchases, but with the share price to book value at around 1.2, this would give meaningful returns to shareholders.  It is worth noting that Shell has 39m more shares in issue than it did 5 years ago, the current long standing buy-back programme is essentially just offsetting the scrip dividend programme.


In another announcement today Shell announced their decision to proceed with its Carmon Creek project in Alberta, Canada, this is expected to produce up to 80,000 barrels of oil per day. Carmon Creek is 100 per cent owned by Shell and back in 2008 they took the decision to delay development of the tar sands due to the expense of extraction.  I hope that in the meantime they have discovered ways to reduce the cost of extraction and achieve a good return on what will be a considerable investment.

Exxon also announced results today with a 14% fall in EPS and like Shell have suffered from the lower margins in refining, but on a quick look appear to have performed better than Shell in other areas.

It will be of interest to see the approach that the new CEO Ben van Beurden takes when he replaces Peter Voser in the New Year.

Globo 3rd qtr update

A technology innovator delivering mobile, telecom and e-business software products and services. I have a holding in my growth portfolio (epic code: GBO).

Globo issued a third quarter update and some additional information that had been requested by investors.

Revenues for the nine months were up 58 per cent on last year to €50.01m, compared to growth at the half-year stage of 52% and sales of €32.03m.  Management state that this performance is ahead of their expectations.

They state that positive free cash flow (FCF) of €0.4m has been generated, resulting in a net cash position for the Group of €11.2m up from €10.8m at the half year.


The additional information re-confirmed that capitalisation of development is in accordance with IFRS, revenue recognition conforms to IFRS and follows the policies set out in its annual report and the rationale behind the disposal of 51% of its Greek facility.  The main new information disclosed - was that the Greek associate is on track and Globo is expecting to receive the second instalment of €500,000 principal plus interest by the end of this year and management also disclosed detailed payment terms for its various forms of trading, which can run for some considerable periods well in excess of 90 days.

Management recognise the risk they are exposed to in extended payment terms, but have stated that as they penetrate more mature markets this will improve the rate of collection of receivables.

There is not much new in the additional information and of course the continuing low level of FCF will still cause some concern, but not surprising in a high growth company with extended terms of payment. 

I cannot see an end to the highly volatile nature of the SP, but the investment case is not much changed from that of a high risk, but potentially high reward stock that requires managing accordingly.  The first rule for any long term investor is protection of capital; so locking in profits on a partial sale to protect your capital while maintaining an exposure is sensible.