Investment Insight, 23/07/2021
Earnings levels and the Macro Picture
In recent weeks there has been concern about rising Covid cases, caused by the increased testing, the increased transmissibility of the Delta variant (compared to previous variants) and easing of restrictions, with the ability of vaccines to fully suppress further Covid outbreaks also being called into question. These factors combined potentially prevent economies from fully reopening or remaining open, causing growth concerns, in stark contrast to inflation narratives which have dominated the time of strategists and asset allocators for much of 2021. As ever, we have not taken a large bet with your money on either of these outcomes, reflecting TS Lombard’s view that the truth probably lies somewhere in the middle. This latest development has caused some market volatility as of late with the reflation or reopening trade which has served investors so well since Vaccine Monday last year, suffering the most (think value funds). This is very much day to day however and serves a reminder as to the benefit of a diversified portfolio.
On the ground, despite this uncertainty, future earnings expectations of companies are now above pre-crisis levels as Chart 1 below, courtesy of TS Lombard, illustrates. In a similar vein, Chart 2 shows that management have been routinely upgrading earnings projections versus what they had previously indicated to the market. Aside from 2018, this has been the strongest period for upward earnings revisions since the Global Financial Crisis.
One company, which you have exposure to through your holding in Unicorn UK Income, that illustrates this broader trend of upwards revision in growth exceptionally well is Somero Enterprises, a leading manufacturer of technologically advanced concrete placing equipment and associated machinery. The company’s core strategy is ‘to provide innovative products and solutions to concrete flooring contractors that enable them to attain the highest level of flat-floor precision at the lowest cost.’ Somero pioneered Laser Screed machine market in 1986 has now grown its portfolio to thirteen products with proprietary designs which are backed by 63 patents and patent applications.
The company was incorporated in 1985 in the US, which is the firm’s major marketplace. As of writing, the company’s market capitalisation is £249.9m and pays investors a dividend yield of 4.39%, one which has grown over 50% over the last five years. Reflecting improving fundamentals, the share price has increased c.125% over the last 12 months. After previously providing earnings guidance in a 6th May update, the board announced earlier this month that they yet again expect to exceed this updated guidance citing stronger than expected trading to end H1 2021 in the US with momentum carrying on into H2 2021. Taken from the company press release:
“The Company’s previous FY 2021 guidance indicated revenues were expected to approximate US$ 100.0m, adjusted EBITDA would approximate US$ 31.0m and net cash would improve consequentially from the original US$ 27.4m target established in our 10 March 2021 final FY 2020 results statement. The Board now expects FY 2021 annual revenues will approximate US$ 110.0m, adjusted EBITDA will approximate US$ 35.0m, and year end net cash is expected to exceed US$ 33.0m.”
According to the managers at Unicorn, Fraser Mackersie and Simon Moon, management at Somero have historically been very good at returning capital to shareholders and would expect these increased projections to translate into boosting an already fast-growing dividend.
Despite the recovery of earnings, dividends are still somewhat off their highs, especially in the UK which according to Link Dividend Monitor fell 43% in 2020 with a recovery to 2019 levels not likely to be seen until 2025. Link further explain that the primary reason for this delayed recovery is that many of the top dividend paying companies in the UK were over distributing and therefore forced to reset their dividends to more sustainable levels. Traditional large dividend payers, such as those in the Energy sector, have been some of the largest detractors.
With the Unicorn team’s focus on sustainability of dividends and focus away from the traditional dividend paying sectors (which they have emphasised for many years), their dividends have already recovered by 30% in 2021 (after falling 40% in 2020), with recovery to 2019 levels looking to be far ahead of the 2025 estimate set for the wider market. Along with the team’s sensible approach to balance sheet strength (many of the companies they own are in a net cash position), growth in earnings of their company selections is a core driver of long-term dividend growth and has helped dividend levels rebound more quickly than the wider market.
According to a 2016 study of long-term returns on behalf of the Norwegian Ministry of Finance, brought to our attention by Dundas Global Investors, managers of the Heriot Global Fund, dividend growth and dividend yield account for 80% of long-term equity returns. We are confident overall dividend levels in portfolios will continue to recover, following the current period of strong earnings growth which we are currently seeing.
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