Even if global political turmoil has cast doubt over the pace at which interest rates will rise, the direction of travel is assured. For dividend-paying companies, it means a higher bar to surpass to gain “income stock” status.
Cue Phoenix, an insurer judged primarily on its ability to keep paying out a beefy cash return, with a step-up in its dividend policy. Payments now will grow over time, no longer reliant solely on it snapping up open or closed books of business. That has started with a 3 per cent boost to the final dividend, its first organic increase, amounting to a total payout of 48.9p a share and a yield of 7.7 per cent, based on the present share price.
What’s changed? Workplace pensions and savings operations gained as part of its deal to acquire Standard Life Aberdeen’s insurance businesses are doing more to pull their weight. Cash from writing new business gives the group, whose history lies in buying up and consolidating closed books, more breathing room in funding its generous dividend.
Long-term cash to be generated by businesses open to new customers came in at £1.2 billion and overtook the decline from its closed business for the first time. The bulk of that came from a rebound in work underwriting the liabilities of pension schemes, an area in growing demand from companies seeking to remove risk from balance sheets. It’s easier to “move the needle” here, according to Andy Briggs, the chief executive, but Phoenix is also gaining traction in workplace pensions. In 2020 it gained management of a single scheme, but last year that grew to 41.
Insurers running closed books have to work hard to keep churning out cash. Those books throw off cash as policies mature and capital held by the insurer against said policies unwinds. Yet natural shrinkage in the size of those books, roughly £800 million a year for Phoenix’s heritage operations, means that business needs to be replaced via M&A. A gradual run-off also means that the unit cost of administering those books gradually rises. For insurers, that means finding ways of cutting costs and making the most efficient use of the capital they are required to hold against policies and generating a better return. Phoenix has proved deft at both.
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The insurer’s Standard Life Aberdeen deal cut its reliance on snapping up more closed books and gave it the operating efficiencies that can accompany greater scale. Synergies from integrating that acquisition, along with its purchase of ReAssure, a former subsidiary of Swiss Re, the Swiss reinsurance group, generated £400 million of cash last year. Some of those benefits will not repeat this year. Management has ponyed towards cash generation of between £1.3 billion and £1.4 billion, below a record level of £1.7 billion. But Phoenix has a habit of beating targets and guidance typically has been conservative.
How sustainable is the increased dividend? Some companies paying high dividends have done so at the expense of balance sheet security and earnings-boosting investment, but that doesn’t seem to be the case at Phoenix. It reckons its subsidiaries can churn out £4 billion of cash between this year and 2024 from policies in force, in addition to £1 billion in cash held at a group level. After taking account of debt and operating expenses and the £500 million annual cost of the dividend, that still leaves £1.7 billion over the next three years for spending on growth. That also does not include cash spawned from any acquisitions. The odds of Phoenix raising those targets again are stacked in shareholders’ favour.
ADVICE Buy
WHY There is a secure dividend on offer, which represents an attractive yield at the current share price
Oxford Instruments
Turbulent markets meant that the takeout of Oxford Instruments by Spectris never stood a chance — but the speed and magnitude of the share price fall that greeted news the larger rival and would-be bidder had dropped its approach misses the fact that another offer could be flushed out.
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Oxford Instruments specialises in designing and making scientific tools that allow for materials to be analysed at the atomic level. A tie-up with Spectris would be logical. Both sell products to many of the same customers but with slightly differing applications, which would have presented cross-selling opportunities.
Shares in Oxford Instruments never got near the £31-a share price on the table from Spectris after it confirmed the approach. Scepticism that a deal could get over the line was understandable, not merely because of the market volatility sparked by the conflict in Ukraine.
Spectris is barred for six months from coming back with another offer, but there’s the chance another player could steal its thunder. Oxford Instruments has accentuated its exposure to some long-term structural growth trends, including the energy transition and rampant demand for semiconductors for use in consumer electronics. It also has been shifting its order bias towards bigger-budgeted commercial customers over academic institutions and trying to design products around what those clients might want.
The result? More consistent orders, 13 per cent higher than the 2019 level during the first half of the year, and steady growth in operating margin, which hit 18 per cent against the pre-pandemic level of 15.5 per cent. That has afforded a forward earnings multiple of almost 24, at the top end of the peer group and against a multiple of 16 attached to Spectris.
Supply chain disruption is one caveat and revenue growth might struggle to keep pace with double-digit order growth this year, according to Peel Hunt. Yet the broker also reckons that a net cash pile and a turnaround plan already in train mean that the business would be easily digestible for a large American conglomerate, even if one takes time to break cover.
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It’s likely investors won’t be won over cheaply, either.
ADVICE Hold
WHY Another bid may come and send the shares higher