23 Sep 2021
Dan Roberts
Portfolio manager Dan Roberts provides an update on the Fidelity Global Dividend Fund and reviews the outlook for global equity income investors. He discusses how recent market movements have left behind a cohort of quality dividend-paying stocks and highlights how the portfolio is positioned to capitalise on this opportunity.
The ideas and conclusions here do not necessarily reflect the views of Fidelity’s portfolio managers and are for general interest only. The value of investments can go down as well as up, so your clients may not get back what they invest.
VIDEO
Markets continue on an upward trajectory with all-time highs across a range of indices on an almost daily basis. Year-to-date winners have been a mix of some of last year’s underperformers, such as banks and energy, alongside the seemingly evergreen sector that is technology. This juxtaposition of cyclical and growth sectors leading the market reflects the fact that investors are grappling between two narratives.
On the one hand, you have a scenario where aggressive fiscal policy helps us to escape the low-growth environment we’ve been trapped in for much of the last decade. In this scenario, there is the potential for inflation to become entrenched, for interest rates to rise and for the market to reward cyclicality and inflation plays.
The second scenario is that as we emerge from the turbulence of the last 18 months, things return broadly to how they were before - low growth, low inflation and low rates. Growth is scarce and the market pays a hefty premium for it.
There are a couple of important observations. First, cyclical stocks and growth stocks have performed better than the market this year, and the performance is coming at the expense of companies that don’t fall into either bucket, most notably defensives. Secondly, valuations are ratcheting higher on both sides.
On the growth side, consider a sector like software and services - a flag bearer for growth - that’s roughly 11% of the market with a P/E multiple in the 40s. On the other side, you’ve got quality cyclicals that are not far off - in some cases, you’re seeing P/E multiples in the high-20s to mid-30s.
Both these buckets look rich to us. For us, the opportunity looks to be in other parts of the market where expectations are more muted and where investor apathy has left valuations at much more attractive levels.
This has been a big headwind for the strategy; an estimated 70% to 75% of the portfolio has defensive attributes and those defensive attributes are not currently in demand. But where I think it hurts dividend investors the most is on the growth side of the equation.
Just to provide some context, if you take the software sector, and add in Facebook Amazon, Apple and Alphabet - together that’s 20% of the market where we don’t participate. We do own some companies which are morphing into software-based businesses, but even here the valuation has moved up quite considerably.
Many companies are facing the most significant period of cost inflation since 2011. Kimberly-Clark is a good example to illustrate the magnitude of the problem for some of these businesses. Historically cost inflation has ranged from being a small benefit to a headwind of about US$500 million. This year, they are looking at a cost inflation of over US$1.2 billion.
The key for us is to focus on the underlying health of the business. We can be less worried about having to get the long-term question on inflation right if we are confident that their products have sufficient brand equity to take pricing without losing volume.
If we look at how the success of the Covid-19 vaccine is impacting Pfizer, according to the most recent update, they are expecting to deliver over two billion shots this year. Pfizer guided a US$1.50 EPS impact just from the vaccine this year. That equates to about US$8 billion in net profit for Pfizer alone.
We would estimate there has been about US$40 billion to US$50 billion added to Pfizer’s market capitalisation this year specifically related to the vaccine. We’re looking at an implied four to five years of net profit at the current run rate already reflected in the valuation.
With that in mind, the questions to think about are whether Covid-19 vaccines will provide more of an annuity-like revenue stream like seasonal flu jabs, the potential for boosters, barriers to entry and, perhaps most important of all, the value of the broader MRNA platform.
Another opportunity is Bridgestone, the tire and auto parts company. In January, they announced the sale of their US Firestone Building Products business for about US$3 billion. That’s a multiple of about 14 times the operating profit of that division, compared to 10 times for the broader group - a realisation of value which was not being reflected in the share price.
Additionally, they are restructuring their cost base, for example, by closing tire plants, which is helping margins. They also announced quite a big dividend increase this year which takes them to a level above their 2019 pay-out ratio. There is plenty of good news to justify the share price, which is up almost 50% year-to-date.
In terms of stock specific risks, worth mentioning are European utilities, especially those with some exposure to Spain, such as Iberdrola and Enel. To the extent that these companies own clean power generation assets, they stand to benefit from the steep rise in CO2 emission permit prices this year.
However, at the beginning of June, the Spanish cabinet proposed to claw back any ‘windfall’ profits from nuclear and hydro assets that were in operation before the CO2 emissions trading scheme was introduced in 2005. There are two things for us to think about here, the first being the direct impact on profitability. Second, and perhaps more importantly, there is the impact on the cost of equity we apply to these businesses given this political interference.
The gross yield is about 3% - the reason we quote the gross yield is because it is the yield before withholding tax, which will differ for investors in different countries. Now, for UK investors, withholding tax equates to about a 30 basis points drag, so you’re looking at a net dividend yield of about 2.7%.
Because we grew dividends last year and the market dividends fell, that equates to a premium to the broader market that is now as high as it’s ever been. The market yield is well below 2%, so we’re looking at a yield premium to the market around 50%.
We have grown dividends every year for almost 10 years that the fund has been in existence. The strategy remains unchanged. We essentially look for good quality, dividend-paying companies with predominantly defensive business models at the right valuation. That combination has served us well and we believe will serve us well over the next few years.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The Fidelity Global Dividend Fund can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund takes its annual management charge and expenses from capital and not from the income generated by the fund. This means that any capital growth in the fund will be reduced by the charge. Capital may reduce over time if the fund’s growth does not compensate for it. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.