Dunedin Income Growth Investment Trust: Update from the managers

Hello. Welcome to this podcast on the Dunedin Income Growth Investment Trust. I'm Cherry Reynard, and with me today are the Trust managers, Ben Richie, and Rebecca Maclean. We're going to be taking a look at the elections both here and abroad, and at what's driving a better few months for UK equities. So welcome, Ben. Welcome, Rebecca. Could a change of government shift the dial in any kind of key areas? I'm thinking I don't know, housing or productivity or sentiment.

Yeah, thanks Cherry. At a high level, my first point would be that the potential for more political stability in the UK broadly is a good thing. And quite quickly, the market and commentators have moved on from who's going to be in charge to what is it they're going to do?

And so, there are a couple of points that I'd put out in terms of implications for the economy, and for sectors. So the first one would be that, there does seem to be a move towards the EU, a gradual movement towards the EU in terms of the commentary from labor, closer alignment on goods and services trades, and also closer on things like research and development and defense, which whilst not going to a point of rejoining, could be positive from a growth perspective for the UK in terms of opening up some of those channels, and also positive from an investor sentiment perspective.

Thinking about the drag that, Brexit's been on the UK economy and maybe unwinding some of that. So, I think that's the first point that could be positive from a growth perspective for the UK. More specifically on a on sectors, the planning reform and housing has been high up on the agenda for labor. And so, addressing some of the supply side issues that we've had in UK housing is something that we would be expecting.

So that has implications for housebuilding volumes. We own Taylor Wimpey in the portfolio, and some other names which are in the housing ecosystem. So, a company like Jesuit or Marshall's and so on, blocking the pipeline of new sites for housing in the UK and increasing volumes would certainly be helpful, from a cycle perspective, for those names.

And then finally, on maybe the green agenda, you know, labor has talked about fiscal prudence. And so, I'd like to get a huge wave of new green spending. But certainly, the commentary around the transition to renewable energy independence and also addressing wrongdoing in the water sector is helpful for a number of companies in particular, you know, companies like SSE or National Grid, which are playing into energy security and the energy transition in the UK and are both held in the portfolio.

I don't see any change in terms of the outlook at importance there. And I think there's also a commitment to get private sector to invest in the sector around renewable energy and innovations, technologies around low carbon heating, for example, solar, and carbon capture and storage. I think they are supportive for the theme, which we see is a structural trend which would benefit a number of companies. So yeah, there's sort of three areas which I think are most notable in terms of potential labor government. and in terms of the speed of change. I think it's important too, in terms of the outcome of the size of the majority in labor. That could have implications for the speed, at which some of these policies come in place.

So that's what I'm watching closely.

Great. Okay. Thanks, Rebecca. Now, Ben, if we thought it was sort of volatile here, that's real trouble on the other side of the channel. So, the French president is facing a very tough set of parliamentary elections. and the French stock market has obviously been very weak in response. I mean, are you seeing an impact on any of the companies in which in which you invest? I think the ones that are listed in France or the ones that have sort of large French businesses.

Yes. I mean, certainly the, the decision to call French parliamentary elections has caused a degree of volatility, in the French market. And, to some degree across Europe and more broadly. But I think it's important to put these things into context as ever.

There's always that the details of the individual national political situation, but ultimately, if you think about Europe over the last 20 years and, and I include the UK in that, you know, we've been through a rolling series of developments in certain, certain might one might call crises, whether it's the GFC, the eurozone, Brexit, Ukraine, Covid.

So sort of difficult situations are more, I think just part of the course for investors and something which, you know, we need to be able to manage as part of our as part of our overall strategy. When it comes to the specifics of the French elections. again, I think it's as much about budgetary responsibility as it is about politics.

I don't think the market particularly worries about, left or right. I think what I worry more about is that France is running quite high levels of budget deficits. Its overall level of indebtedness is quite high, and you've got two political parties, whether it's the left or the right, or to organizations that look as though they may want to spend more.

And I think that is what is ultimately putting pressure on French bond yields, along with, the overall sense of uncertainty that comes with what's happening in reality. Macron will most likely continue to be president for the next three years. and in the past, we've seen situations where presidents have worked with parliaments that are controlled by different political parties, but I think it's the sensitivity of the French budgetary position today. You know, combined with that degree of uncertainty that has led to a bit of a concern when we look at the actual overall impact on companies that we own within the portfolio, we think it's modest. We don't have, any banks currently in the portfolio.

That sort of financial weakness is probably the main area that you saw in terms of French companies selling off. We do have a company called Eden Rent, which is a digital payments business. It has about 10% of its revenues coming from vouchers that are issued in France. I guess potentially that's an area that could come under some pressure.

But equally, it's an extremely popular, part of the French policy and something deeply embedded into French culture. So, we don't necessarily see huge pressures there either. So overall, it creates a degree of uncertainty. That really though, is a is a feature of life. I think more broadly for investors across the UK and Europe. and we don't really see any major individual issues for the companies in the portfolio.

Okay, great. Thanks, Ben. Now, Rebecca, it's been a bitter few months for the UK stock market. do you have a sense of where that strength has come from? And are there any signs that this long run of outflows that we've seen from the UK market is finally starting to reverse in terms of near-term performance?

The Footsie 100, which is the 100 largest companies in the UK, has performed well on a test return basis and has outperformed the S&P 500 and MCI world, and that's in the three months to the 27th of June, with a total return of nearly 5%, so good level of performance. The best performing sectors have been health care, communications, financials, and commodity sectors. so within healthcare, AstraZeneca, which is a large weight in the index, it has strong performance on the back of a positive Capital Markets Day, where the company outlined increased expectations for their pipeline in terms of the scale of the opportunity, but also the breadth of the different treatments which they have in that pipeline, too, which meant that analysts raised their expectations for revenue growth over to 2030. So that's been taken by the market. And then from the materials perspective and commodities, better global economic expansion has led to, higher commodity prices. So that's been supportive. And we've seen the large caps outperforming the mid-caps, in the UK market. So, it has been a good period of performance.

But if we think about taking a step back about sentiment towards the UK, we have seen relentless selling of the UK market for many reasons. But given a number of those excuses to be negative on the UK are now abating, I do wonder whether we're approaching low tide in terms of sentiment towards the UK. so today we had the Q1 GDP figures for the UK economy, revised up to 0.7%.

Inflation is under control. political stability, is on the horizon. and we've got imminent interest rate cuts this year. So, lots of very sort of reasons to be negative of have gone away and, and do sort of wonder whether that will lead to a shift in sentiment and flows. And we're not seeing it yet. We, we continue to see outflows out of UK equities.

That does feel that the tide could be turning okay. That could be good news. now, Ben, National Grid, which is a major holding in the portfolio, has recently made a significant rights issue. I wonder if you could talk a bit more about that. You know what? What the proceeds going to be used for?

Yeah. So, it's been quite an interesting development. National grid is, announced the rights issue around 7 billion pounds raising sort of. I guess 15, 20% of the market cap the company in the process. it's quite a big, quite a big absolute amount of money in context will be in the shape of that company less. So why are they choosing to do that? Well, they're coming up to the period where the next, regulatory payment, the returns are about to be set, and they want to be in a position where they're prefunded for that and in a strong position, essentially to negotiate with the regulator over the returns that they're going to be able to generate on the investments that they make. And those investments are incredibly substantial. So, the investment plan I think stretches up to 60 billion, over to the end of the decade.

And that's really all about putting the backbone in place to electrify the UK to connect, renewables, and to bring that energy where it's needed, primarily taking from the north, and bringing it to the south and electrifying the economy so that we can increasingly support the development of EVs and that sort of lower carbon economy. So, it's quite an interesting situation.

The shares didn't react particularly well to that. I think there were two reasons. One, suddenly you've got a big, placement of additional stock that people have to swallow. And secondly, they also revised down their dividend by the amount of the issuance of the rights issue as well. So, you if had a modest dividend cut to go with that.

But both of those things, I guess, seen as potential negatives. The longer term, though, is that this puts them in a very strong position. the balance sheets is now fully funded through to the end of the decade. and the growth rate in the asset base is going to accelerate from here. So, we think at this point you've got an extremely attractive proposition, you know, a decent yield which will grow at attractive rates from here through to the end of the decade.

That's it's relatively undemanding and very high visibility, ultimately, on the returns that you can make. National grid's been the kind of company that's offered a low, sort of 11, 12% type of turnover over the long term. We think that looks quite attractive. We think it should be able to deliver at least that, going forward from here, and we think overall that makes me very attractive proposition for investors, particularly when, you know, a say 40 to 50% of that is likely to come in the form of income. So, when we look around the market as something to own, as a core position that can generate, attractive levels of income for, as quoted above, certainly ground in real terms, and offer some attractive capital returns within a very, very highly visible framework that looks quite attractive.

So not only have we participated in the rights issue, but we've also taken the opportunity, from the weakness in the shares to add significantly, to our position as well. So, we see that as sort of a little bit in the short term, a little bit of a headwind to performance. but over the long term, we see this as a really attractive, opportunity to build a big position in what should be a very, strong, stable and steady prospect for the long term.

Okay. Thanks, Ben. Rebecca, can you walk me through ConvaTec? That was a new purchase over the month.

Yeah. So ConvaTec has knowledge and experience in developing medical treatment solutions for, a range of areas. So they do dressings for wounds, they do infusion care for insulin pumps to treat, diabetic patients, but also potentially for Parkinson's treatment. And they do ostomy care also.

So, they've got quite a wide range of different products, which have good level of visibility, of growth because they, get into more chronic diseases. And so, some of the structural trends around aging population and increasing incidence of chronic conditions, should support the company's, outlook for visible and less cyclical earnings. And the company has got some strong brands and market positions, particularly in that infusion care, as mentioned.

What we like about the business is that there's been a real focus from management in terms of its product pipeline. The number of patents that it has filed has more than doubled in the last three years, and that product innovation and product launches should support the company's ability to grow in the future. Meanwhile, from a profitability perspective, the company is focusing on efficiency, and this is translating into better margins.

So, the company currently has about low 20% operating margins. but is targeting, for that to increase to mid-20s. And when we look at peers, we think there's a potential for margins to text a higher than that over the medium term. So, we think that yeah, not only is there good resilient growth at the top line for revenue perspective, we think that earnings could be supported by margin expansion also.

So that translates into a healthy outlook for growth. Shares have been weak of late. following news that one of its products, which heals very complex surgical wounds is a sort of skin substitute. It is at risk of not being covered by insurance in the US. And so, there are some question marks about what that means in terms of the company's ability to deliver, clinical evidence, in order for the regulator's, needs, but also what that means from a growth perspective for the business. but shares have been very weak on the back of that. And we think that it's discounting an overly negative scenario for the business and doesn't reflect that improving quality and growth outlook that we see for the business. So, we've continued to add to shares, own weakness, and maintain that position, size.

Great. Okay. Thank you. and then just finally, Ben, you mentioned that you've got a stronger kind of pipeline of opportunities, and you've seen in some time, why is that? And is that focused on any particular area?

And so, it's a good question, Cherry. I think it's a combination of two things, really. One is price movements in the market and also, I think our own research and idea generation. So, it's a combination of those two elements really. So, I think first of all, from a sort of idea generation perspective, you know, we're quite fortunate to have a very good overview of coverage of the UK equity market and indeed European and global markets. So, we're in a good position when it comes to being able to leverage that.

The wider team that we have, here at Aberdeen and we've got nearly 60 people doing what we call developed markets across UK, US, Europe, smaller companies. So that puts us in a pretty good position to be able to identify ideas and that, sort of, I guess research engine is sort of, starting to come to the fore.

So that's been pretty helpful. And we've got very comprehensive coverage of the UK market. And we run, you know, a number of different strategies in that market, from income through to sustainability to small and mid-caps, as well as running some value strategy. So that means that we've got quite a lot of, you know, pools to pick from.

So that's sort of overview of the market piece is quite interesting. And then the second side. But I think there's also just been the, the dynamics in the market where we've actually continued to see companies do relatively well in terms of their own, corporate performance. And at the same time, we've seen share prices that have been, you know, perhaps a little bit indifferent to that.

And I think that combination has led to us having a number of things which look really quite attractive from, from, implied returns perspective. and at the same time, also having, you know, the research and the support behind us to be able to make those decisions. So, I think where we sit today, there are back and I keep a sort of long watch list of sort of next best ideas for the portfolio.

And that that list is, you know, as long as it as long as it has been and in fact, we actually, drew down another 6 million pounds of borrowings from our debt facilities last month to enable us to be able to increase the gearing a little bit more in the portfolio and add a bit more capital to some of those, to some of those positions.

I think that reflects the fact that the gearing was a little bit low, relative to history and to peers. So, there was scope to move that up a little bit more. and also reflecting the fact that we do see increasingly interesting opportunities. we've talked about a couple of them today. One was adding more to the national grid, position following the a little bit of a sell off after the rights issue announcement.

ConvaTec has been a little bit weak, on some of the issues that Rebecca talked about earlier. And both of these companies, we see, a very attractive, multiples with really good long-term prospects ahead of them. So, and when we think about it, you know, those sorts of opportunities are spreading out across the market. So, you know, we've probably got 5 or 6 segments which, you know, are close to potentially being included in the portfolio, all offering, you know, attractive long term return prospects, you know, solid initial dividends and good prospects for income growth. And so overall, that that feels like a pretty good place to be. and as a result, we're feeling quite positive, about the prospects for total return and income growth from the portfolio.

Great. Okay. That seems a good place to end.

So, we'll wrap up there. many thanks, Ben, and Rebecca, for all those insights today. And thank you so much for tuning in. You can find out more about the trust at Dunedin Income Growth dot co dot uk. So, until next time.

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