The indiscriminate discount applied to UK domestic franchises is generating interesting opportunities to invest in some fantastic long-term, cash generative companies at attractive valuations, according to David Goldman, co-manager of the BlackRock UK Income Fund.
The UK equity market continued to climb higher over the course of 2017, benefitting from the positive global economic backdrop leading to robust earnings growth. However, as Brexit negotiations continue to stutter, investors remain cautious and this has been reflected in the substantial discount seen in the share price of UK domestic companies. The caution is not unwarranted, said Mr Goldman, but a flexible approach is crucial to delivering strong investment performance through the cycle given how market leadership changes over time.
“It was a strong year for UK dividend payments in 2017, albeit boosted by sterling weakness and a revival in mining payouts having cut their dividends in 2016. Although the outlook for earnings and cash flow growth continues to improve given the backdrop of synchronised global economic growth, dividend growth is likely to be more muted in 2018 if current exchange rates persist while we are unlikely to see the commodity-related boost repeated. In this environment, we believe that stock selection will continue to be crucial; identifying those companies with strong cash generation that are thus well positioned to grow their dividends,” Mr Goldman stressed.
He reiterated that dividend growth is always important, particularly as inflation picks up, and so he would encourage investors searching for yield to consider both the current yield on offer from an investment but also its ability to grow the payout.
“For example, we continue to like companies in the consumer staples sector whose cash generative business models have driven sustained and rapid dividend growth over many years in contrast to more cyclical, capital intensive sectors where payouts have proved more volatile.
“Tightening monetary policy, as demonstrated by rising interest rates in the UK and US and the withdrawal of Quantitative Easing, suggests that we are on the path of normalisation; however, we expect this will impact the cost and availability of credit for companies. It is therefore crucial to invest in companies with sustainably strong cash generation and robust balance sheets such that they are able to perpetuate growth over the medium and longer term from within and not by relying on unlimited cheap credit."