Bad luck versus imprudence: Take a leaf out of a Lincolnshire farmer's book
Much needed shift in corporate culture needed
The impact of the current unprecedented environment on UK income investors has been well publicised. But as we reflect, it is important to make a distinction between bad luck and imprudence.
My father is a farmer and I admire, in an admittedly biased manner, how he runs his business.
Farming is a commodity sector with a cyclical and unpredictable earnings stream attached. Farming is also capital intensive - it costs a lot to invest in more land and machinery.
Growth is not easy, nor cheap, therefore compounding growth really is tough and ensuring his business carries negligible debt is paramount. This affords flexibility and allows him to invest when opportunities arise.
This flexibility is enhanced by taking only a variable amount of capital in the form of a dividend out of the business. Capital allocation is focused on reinvesting sustainably to make the business more efficient and competitive.
A dividend is an after-thought, therefore, which has fortunately always been enough to put food on the table.
I digress, but my point is many listed PLCs can probably take a leaf out of his book, particularly those facing similar compounding challenges posed by commodity and capital-intensive characteristics.
We believe the Covid-19 pandemic will lead to a broad and much needed shift in corporate culture. We always think about the companies we invest in through a stakeholder framework lens, with shareholders only one of a number of stakeholders.
To make attractive shareholder returns through a cycle a stakeholder framework needs to be balanced: employees need to feel motivated, regulation needs adhering to, governments require tax receipts and customers require a good value proposition.
A crucial question is whether UK equities can continue to be an effective and sustainable source of income. We believe the answer is yes.
It is important to recognise that UK-listed companies are generally diversified, with 70% of their earnings generated offshore, and we should also remember that the UK is a sound home for PLCs with a rigid legal framework, pro-business (and democratic) political backdrop and a safe environment in which to operate and live.
In addition, we believe companies will learn from the consequences of imprudence and adjust their capital allocation policies accordingly.
As always, it is imperative to remain selective to give oneself the best chance in compounding returns over the long term.
We will continue to steer capital away from imprudence as best as we can and largely avoid sectors, like farming, where the economics are inherently tough.
We believe this, alongside our quality framework and focus on companies with sustainable cashflow growth profiles, should continue to lead to both optimised income and attractive total shareholder returns for our clients.
Ben Needham is portfolio manager of the Ninety One UK Equity Income fund
