UK Edition
Questor: buy Lloyds - it's set to become a dividend-paying machine
THE huge swing away from “bond proxies”, shares that a mere few months ago were loved for their bond-like attributes of dependable income, continues apace.
The market is convinced that Donald Trump, among other forces, will finally end the era of central bank control and instead usher back in a “normal” era of wage growth, rising rates and inflation.
Richard Buxton, chief executive of Old Mutual Global Investors, said on Wednesday: “The moment monetary policy would reach the end of the road was when it was in politicians’ interests to see it happen. That moment has come. People have voted for wage growth. They have voted to get their debts inflated away.”
He does not think the market is mistaken.
But he pointed to the violence and speed of the trend, apparent now in the indiscriminate selling of some sectors and equivalent buying up of others – “a headlong dash from one side of the boat to the other.”
Where does that leave Questor’s income portfolio? Not in an especially comfortable place.
With the year-end approaching, it is timely to look back at our picks since the launch of this project on September 30. The aim, remember, was to deliver a sustainable 5pc income from a £500,000 portfolio.
The need for income was arguably at its most extreme in those months after the Brexit vote, when rising share prices had crushed dividend yields even further and when, with deflation still the biggest cause of anxiety, bond yields were also falling, confounding the pre-referendum predictions.
But it was arguably also the worst possible time to be out shopping for income: a “darkest-before-dawn” moment.
National Grid, which of all our holdings fits most closely the perception of a bond proxy, is a case in point.
On October 6 we paid 1058p for this company, delivering the then modest yield of 4pc. It has been hammered, closing yesterday at 916.1p.
It will continue to deliver income, however, and confirmed yesterday that £4bn will be paid as a special divi in 2017, resulting from the gas distribution business sale.
Other holdings have fared hugely better; and more recent buys have been selected with a firm eye to the unfolding pro-growth backdrop.
Lloyds Banking Group
Today’s tip, disliked by professional investors but of enormous interest to private investors, is Lloyds Banking Group.
The downsides of high street banking are familiar: regulatory clampdowns and fines (Lloyds has spent a colossal £17bn addressing historic payment protection insurance mis-selling); further capitalisation requirements and (in this low-rate world) narrow interest margins.
But in Lloyds’s case none deserves to stick.
After announcing a £1bn PPI hit in October, the bank indicated an end in sight.
Investec, the broker, reckons a further £1bn might need to be spent between now and 2019, which is the final regulatory cut-off for consumer complaints. Once ended, that vast haemorrhage of cash will divert back to profits and potential distributions.
Other holdings in the form of the bank’s gilt portfolio are also free to use either for purchases or to distribute as dividends, thanks to a one-off accounting “reclassification”.
Profits have been growing, but even if they flatten toward the end of the decade, an ongoing reduction in costs plus this dramatic freeing up of cash should keep dividends flowing. If the dividend rises modestly to 5p by 2018, that would give a yield at today’s price of about 8pc.
Rising rates should help profitability further. And if gilt yields continue to rise, Lloyds could benefit – along with other businesses mentioned here including Royal Mail – from a reduction in the final salary pension scheme deficit. Questor will buy £20,000 shares (a 4pc holding).
Lloyds Banking Group has injured income-seeking investors in the past: it waged a court battle in order to force through a buyout, at face value, of several tranches of bondholders. For many savers this meant a loss of capital and income. The move, however, was part of a cost-saving restructuring from which today’s shareholders might benefit handsomely.
Questor says: buy at
Ticker: LLOY
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