Three stocks for income

Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Simon Gergel, fund manager of the Merchants Trust, picks three income stocks.

Our investment approach is based on building an actively managed, strong-conviction portfolio of attractive, higher-yielding equities. We analyse companies in three main areas.

We look for strong fundamentals: these include the competitive position of the business, the strength of its balance sheet and cash flow, and its corporate governance framework. We have a strict valuation discipline: we look to buy shares that underprice the intrinsic value of the business, and to sell those that are fully priced. Finally, we place a strong emphasis on themes. In other words, we look for companies that will benefit from long-term structural changes or cyclical developments. This analysis also seeks to avoid “value traps” – companies that may look cheap, but are structurally challenged.

Here are three examples. Firstly, United Business Media (LSE: UBM). This company has been radically transformed over the last decade. It has gone from being a conglomerate with lots of exposure to declining print media, such as magazines, to becoming mainly involved in arranging and running exhibitions. Exhibitions and trade shows are attractive businesses (many are “must-attend” industry events) with high barriers to entry. They’re cash generative, earn high returns, and there are structural growth opportunities – not least in emerging markets, which represent a large part of the group. UBM’s shares are currently depressed, partly due to negative reaction to a fund raising put together to buy a US exhibition business. The valuation is modest with a low double-digit price-to-earnings (p/e) ratio, a dividend yield approaching 5% and strong underlying cash flow.

Inmarsat (LSE: ISAT) is a leading provider of satellite communications services. It supplies shipping firms, airlines and government agencies with voice and data links around the world, including in remote areas. The business is currently launching its next generation of satellites. These allow greater bandwidth and will help to develop interesting markets, such as Wi-Fi on aeroplanes, high-speed broadband on ships, and numerous defence-related opportunities. The business has high barriers to entry, including an established customer base, satellite fleets, spectrum, geographic reach and technological capabilities. United pays a dividend yield of over 4%, which it has consistently increased in recent years. Cash flow is expected to pick up in the future as the new services start to contribute sales and profits. This makes the valuation look attractive.

Property company Hansteen (LSE: HSTN) has a large portfolio of industrial assets in Germany, the UK and other parts of Europe. Industrial property is starting to attract investors, who are being drawn in by the low level of new development and the fact that demand from tenants is gradually recovering. This sub-sector has some of the highest property yields around, even though the broad base of tenants diversifies individual customer risk. Hansteen’s management team has a strong record of buying cheap assets with a large amount of void (vacant) space, and of working hard to fill that space with new tenants before selling the assets on at a profit. We are currently at an interesting point in the industrial-property cycle. Hansteen’s large German portfolio is valued on a rental yield of around 9%, which we believe understates the true worth of the assets. The shares are priced at around asset value, which is attractive, and they carry a 5% dividend yield, which is growing.