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Ben Ritchie and Georgina Cooper, Investment Managers, Dunedin Income Growth Investment Trust PLC
November’s COP26 UN Climate Change Conference concluded with a deal of sorts, albeit an inelegant one. In the messy and fractious world of international politics, competing interests have proved a significant barrier to agreement in key areas. Could the private sector go it alone?
The private sector is undoubtedly stepping up. According to the Net Zero Tracker initiative, one in three of the largest public companies in the G20 now has a net zero target. This includes BT, British Airways, Land Securities, AstraZeneca and Sainsburys, whose carbon targets were established before January 2020, and more recent additions - Sky, Barclays, Shell, Unilever and HSBC.
There are reputational reasons to make these commitments and increasingly, economic reasons too. Carbon costs seem likely to rise. Certainly, it is a gamble to assume they won’t, given the regulatory, governmental and investor push behind the energy transition. Companies likely to be worst hit need to ensure that they have alternative, profitable business lines. It is posing significant questions for corporate management teams on capital allocation and, in many cases, they are answering them thoughtfully and with an eye to the future.
However, the corporate sector cannot do it alone. First, companies respond to incentives and it is up to governments to put those incentives in place, whether that is financing structures or regulatory frameworks. Second, a significant share of the world’s emissions do not come from the private sector, but from state entities. The actions of the large, nationalised oil companies matter every bit as much as the private energy giants.
In this way, it needs to be a collaborative effort, with both sides aligned to deliver on carbon targets. We are clear on the role of the asset management sector. We are stewards of capital and need to engage, to encourage accountability and to ensure that companies make good decisions and stick to them. As COP26 has shown, there is no single element that will move the dial on temperature rises, but only a multi-layered response.
Building back bigger
After a lengthy period when governments were trying to shrink the role of the state, big government is back. This has been driven by the need to rebuild after Covid, but also to address climate change and other pressing social issues. This means government spending on areas such as health, infrastructure or social projects is likely to increase. What does this mean for the companies in our Dunedin Income Growth Investment Trust portfolio?
Economic orthodoxy suggests that the growth of the public sector can lead to a ‘crowding out’ of the private sector. This would be a concern - levels of private investment are already low as companies have halted spending amid the uncertainties of Covid-19 and Brexit. However, we don’t see this as a significant issue in the short-term. Interest rates remain low and the corporate sector is in good health. There is enough demand in the economy to support both public and private sector growth.
We always need to be careful on the quality of investments made by the companies in our portfolio. Can they generate sufficiently high returns on the investments they make to keep up with a higher cost of capital? Our focus is the sustainability of longer-term growth.
There may be inflation risks. It is plausible that higher public spending could start to push up inflation, at a time when supply chain disruption and the recovery from Covid-19 are already creating inflationary pressures. It is an important part of our process to find those companies that we consider to have pricing power, in the hope that company earnings and performance will be more resilient than the wider market. This type of environment puts that process to the test. Do companies have the ability to increase margin or put up prices? Do they have a strong bargaining position on cost with suppliers? It is an area where we will keep a close watch.
The dividend recovery: real or illusory?
After a dismal year in 2020, which saw dividends slide, the latest statistics on UK dividends made for impressive reading. In the third quarter of 2021, dividends recovered 89.2% to £34.9bn. However, there were nuances to this apparent strength. The strongest gains were seen in the mining sector, where earnings bounced back on higher commodity prices and there were a number of special dividends. Banks also made a significant contribution to dividend growth, having been unable to pay dividends this time last year. A sharp rebound in oil prices also encouraged the oil majors to increase their payouts.
In other words, the strongest gains have come from the most cyclical areas. This is great for a short-term bounce, but we want to find companies that can deliver genuine long-term growth in dividends. In general, these did not see the dramatic falls in 2020, so have not seen the dramatic rise in 2021, but have longevity. We will get a better reading on the overall health of dividends in the UK market in March, when most companies report. However, the longer-term growth rate for dividends is still very healthy, at 3-5%.
Stock focus: Coca-Cola Hellenic
Coca-Cola Hellenic has been a long-term holding in our Trust and is in an interesting position today, from both a capital and income perspective. Its end markets are diversified geographically, and include emerging markets such as Nigeria and Russia, alongside developed markets such as Ireland and Italy. We believe its emerging market exposure gives it more compelling growth potential compared to other bottlers. Consumption per capita is far lower in many of these countries and therefore there is more scope for it to increase.
Previously disliked for its high cost base, Coca-Cola Hellenic’s management team has put significant focus on cutting costs in recent years and making its business model more agile. It did this in the nick of time, ensuring the business was resilient through Covid. It is also helping it manage inflationary pressures as the global economy recovers.
Coca-Cola Hellenic has already demonstrated its pricing power helped by the strength of the Coke brand, as well as market leadership to pass through rising costs within the supply chain. Its more recent focus on price relative to pack size presents a further lever to sustain this. We believe there is also the potential for corporate activity: they have recently acquired the Coca-Cola Egyptian assets and there may be opportunity with the IPO (Initial Public Offering) of further African assets in the new year. It remains at what we believe is an attractive valuation, with a well-covered dividend growing at around 10% per year historically.
Companies selected for illustrative purposes only to demonstrate abrdn’s investment management style and not as an indication of performance.
Important Information
Risk factors you should consider prior to investing:
-The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
-Past performance is not a guide to future results.
-Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
-The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value [NAV] meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
-The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
-The Company may charge expenses to capital which may erode the capital value of the investment.
-Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
-There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
-As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
-Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
-Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
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