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Schroder income duo back embattled UK supermarkets despite dividend cuts

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14/11/2014
Nick Kirrage has begun adding supermarkets to the £1.5bn Schroder Income fund he co-manages with Kevin Murphy, expecting a significant boost to dividends in the long term.

The manager has initiated small positions in Tesco, Sainsbury’s, and Morrisons, despite the continued struggles in the highly competitive food retail space, and the investigation into Tesco’s recent £263m accounting error.

At current valuations, supermarkets are an attractive investment in future dividend growth, the manager said.

Year to date, the share prices of Tesco, Sainsbury’s and Morrisons have fallen 43 per cent, 28 per cent and 34 per cent, respectively.

In its latest set of results, Sainsbury’s said it would likely cut its end of year dividend to fund cheaper prices in the battle for customers, while Tesco recently slashed its dividend by 75 per cent.

“Supermarkets have started cutting dividends but, when you look at companies that have cut dividends in the past, many go on to have fabulous dividend growth in the future,” Kirrage said.

“Those companies that cut dividends do not reduce dividend yield as much as you would think, because the shares have fallen so far. So Tesco and Sainsbury’s still have reasonable yields.”

Kirrage compared supermarkets to tobacco and consumer staples stocks – businesses that used to be considered uninvestable, but have developed into stable and reliable dividend payers.

“Supermarkets might be the new dividend stocks in ten years’ time,” the manager said. “Tobaccos, for example, are now considered very stable, long-term businesses with good dividend yields, but ten years ago people thought they were basket cases.”

He also named UK banks as examples of companies that are likely to offer strong dividend growth in the future; his top ten stocks already include HSBC, RBS, and Barclays.

“The quintessential dividend-paying stocks that everyone wants are really expensive and, if you overpay for the stock, you are going to get terrible returns,” he said.

 “We are looking for businesses that provide future income: the utilities and tobacco stocks of ten years ago.”

However, the largest positions in the fund remain the traditional dividend payers, such as AstraZeneca, GlaxoSmithKline and Vodafone, while the supermarket investments are a longer-term story.

Over three years to 12 November, the fund is one of the strongest performers in the IMA UK Equity Income sector, returning 69 per cent versus a 45 per cent average, according to FE.

However, over the past 12 months, performance has started to lag a little, with the fund dropping into second quartile, although it is still outperforming its peers with a return of 4.6 pre cent versus an average of 3.7 per cent.

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