Hello, and welcome to the Morningstar series "3 Stock Picks." I'm Emma Wall and I'm joined
today by John Stopford, Manager of the Investec Diversified Income Fund.
Hello, John. Hi.
So, what's the first pick you'd like to highlight today?
Okay. So, all of the investments that we look to own, we're building the portfolio from
the bottom-up across a range of different asset classes and the key criterion for us
is they have to have an attractive yield but ultimately has to be sustainable. It can't
be one that's subject to a lot of potential risk. And generally, we want things that are
attractively valued supported by fundamentals and also attractive investor behavior.
So, the first example we have is a stock we like, Cisco (CSCO). It's a business that's
somewhat in transformation. So, it's evolving from an old tech hardware transactional-based
business to one that's relying much more on recurring income which we think is a very
valuable commodity. So about 30% of the business now is an annuity stream. It's pretty attractively
priced. It's a moderate yielder. We don't want to chase yield. It yields about 3.25%,
but it has growing free cash flow, improving margins.
Free cash flow yield of about 8% and it's only paying out about 40% of its revenues
in terms of dividends. So there's plenty of scope to support and grow dividend over time
and it's generally a business that we think has got good quality, good value and where
we can see a decent return to shareholders which is at least half of the free cash that
they generate they look to return to shareholders either through dividends or in addition through
buyback. So, it's a perfect company for us. And the second pick is a little less well
known, isn't it? Yeah. So, we're running a fund that can invest
across different areas, different asset types. So we also invest in listed property which
we look alongside equity. It's another growth-orientated asset and there a company that we've liked
for some time is a REIT called Tritax Big Box (BBOX). So they are in the business of
running large distribution centers and there's a trend going on with online retailing growing,
et cetera, for companies to centralize their distribution.
So, something like M&S which is a client of Tritax, they used to have about 100 distribution
centers and they are now down to three. So that consolidation supports, we think, demand
for these big scale sites and Tritax is a leader there. They have very long leases typically
well over 15 years on average. They are currently earning a yield of around 4.5% and they are
growing at about 3.5% a year. So, it's a pretty stable not hugely exciting business. We are
in the sort of defensive area of the market but a decent yield, some growth and relative
stability in an area that we think is benefiting from change.
And how sensitive are they though to losing a key client? I think you mentioned before
we started rolling Amazon was a client was of theirs and of course, the leader in the
e-retail business. If they lost Amazon would there be a change?
Well, at the moment, there's a shortage of these kind of sites. So, it's all about the
location, so particularly in terms of things like roads and rail networks. It's about the
size of the site and availability, et cetera and there is at the moment a shortage of supply
versus demand. There are more companies looking to centralize than there are sites available.
In time, that may change, but at the moment it's a pretty secure business we think. And
then also, they are generally locked into pretty long leases, so on average I said over
15 years' lease. So, yes, Amazon might try and get out of it, but it's not obvious why
they would. I mean, the bigger risk I guess is that some of their clients might fail.
But I think they'd be able to replace them fairly easily.
And what's the third and final pick? Okay. So, again, the first that we've talked
about are basically growth-orientated assets. They will do well when economies are doing
well. Portfolios have to have more defensive positions as well. The problem for investors
is finding defense and yield at the same time. So, one of the areas we like is the local
government funding agency in New Zealand. It's owned 20% by the New Zealand government
and then the other 80% by 30 municipalities and they are committed to maintaining the
same rating as the New Zealand government. So they are essentially supported and they
are deliberately targeting high quality. They are currently rated I think AA+ by Fitch and
S&P in line with New Zealand. But because they are an agency bond rather than the government
itself, they typically pay you a yield premium anywhere between 40 basis points to 90 basis
points at different points along the curve and so we own, for example, the 5.5%s of 2013.
They will behave like a government bond but they are yielding closer to 3% which in today's
world is pretty good and in a market where we think we're going to get rate cuts which
is generally pretty good for government bonds and linked bonds like that. So New Zealand
rates were cut earlier with a cut last month and they've said that they are likely to ease
policy further. So, defensive asset, supported by monetary policy, decent yield, what's not
to like. When 60% of the market, the government bond
market, is yielding less than 1.6%, pretty attractive.
Exactly. John, thank you very much.
Thank you. This is Emma Wall for Morningstar. Thank you
for watching.