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Questor: here is our replacement for Dairy Crest as the cheese maker quits the stock market
Questor Income Portfolio: we have set out to find the best combination of yield, dividend growth and valuation
Dairy Crest is about to leave the stock market so we must now name its replacement.
The dairy products group, maker of Cathedral City cheese, is being taken over by a Canadian rival. Its shares are expected to cease trading this evening and shareholders should receive cash for their holdings, at the rate of 620p per share, within two weeks.
When we reported the takeover in March we asked for suggestions for a replacement holding for this portfolio and received a great many from both readers and professionals.
Most named individual stocks, however – suggestions included Halfords, Direct Line and Phoenix Group – and we have decided to put the proceeds from Dairy Crest into an investment trust, to add to our existing holdings in Schroder Income Growth, Invesco Income Growth, Standard Life Property Income, Regional Reit and the Baronsmead and Northern venture capital trusts.
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There are several reasons for this. The first, prosaically enough, is that the portfolio is not hugely diversified and a trust, a listed fund, spreads our risk better than a single stock.
Second, there is a wide choice of well run income-focused trusts available at a discount at present. Third, many trusts maintain “income reserves” – money held back in good years and ready to support dividends in leaner times.
This last point is potentially very valuable in view of our portfolio’s overriding aim of maintaining and ideally increasing its income every year.
We will therefore look for the investment trust that can offer the best combination of decent yield, strong dividend growth, attractive discount and healthy revenue reserves.
There are several strong contenders among trusts that seek income by investing in British shares and our choice is one that has featured in the past in Questor’s “investment trust bargain” column: Lowland.
First the raw numbers. The trust yields 4pc, has raised its dividend by an average of 10pc a year over the past five years (and by 7pc annually over the past 29 years), trades at a worthwhile discount of 7.1pc and has just over a year’s worth of dividends in reserve. Together, the dividend growth record and the reserves make the trust’s dividend virtually bombproof.
Capital performance has also been impressive. Over the past 10 years, with dividends reinvested, the shares have gained 364.5pc. We also like the fact that James Henderson, the co-manager, has been with the trust since 1990 and has an appreciable stake in it.
While we have in the end decided to replace Dairy Crest with a trust and not an individual company, we still wanted among the trust’s holdings the same characteristics that we mentioned in our column in March as requirements for a single stock: strong growth prospects, dividend sustainability, good cash generation, high returns on capital and profit margins, pricing power and barriers to entry.
Broadly, this is what Lowland offers. It is a mix of small, medium-sized and large companies; the first two offer better growth prospects and the last offer stability. It seeks “capital and income growth” rather than “absolute dividend yield”.
The trust invests mostly in British companies and looks for “areas where the UK has globally competitive, world-leading companies”. These companies will tend to have high barriers to entry as, in the manager’s words, “their products tend to be specialist and have been fine-tuned over many years”. This allows them to generate reasonable margins and makes them well placed to generate cash.
The trust has a “mildly contrarian” style and holds stocks for an average of five years to give time for recovering companies to deliver on their potential. It is well diversified with 113 holdings.
Despite the trust’s strong record the shares have been falling since the beginning of last year, no doubt partly because of Brexit.
But shares and dividends don’t go in opposite directions forever and Questor expects the share price to recover before long. We therefore think this is a good time to buy.
Questor says: buy
Ticker: LWI
Share price at close: £13.45
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