Finding investments that have both a reasonable yield and the ability to increase it by growing their earnings can be tricky for income fund managers. While these opportunities certainly exist, they tend to be less obvious than the “fad stocks” of the day, such as technology stocks, which regularly have eye-watering valuations.
However, undiscovered growing stocks with good yields can sometimes be found in sectors that may have been under pressure for years. Consolidation through mergers, failures and companies withdrawing from the market can create conditions for very substantial margin improvement and growth, even when a relatively small amount of demand comes back and a little pricing power returns.
These capital-cycle investments tend to be higher yield, under-researched, have low valuations, enable growing dividends and can produce market-beating total returns.
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Inditex: fast fashion stands its ground
Inditex (Madrid: ITX), the owner of retailer Zara, has been under pressure from online cheap clothing retailers and has had to build its own substantial new internet presence. More recently it has also suffered from the reduction of its business in China and Russia. To add to the market concerns, the founder is now ceding control of the management to his daughter.
Nonetheless, compared with happier pre-pandemic times, the business is in better shape than before, with a strong internet presence, better supply chains compared with its competitors and is generating strong cash flow and dividends. There is also considerably less competition remaining from physical stores. A dividend yield of 5% and growing is achievable in 2022.
UPM-Kymmene Oyj: the paper producer branching out
UPM-Kymmene Oyj (Helsinki: UPM) is in a sector that I’ve always disliked. The paper and pulp industry has always grown its capacity faster or in line with demand, and frankly southern Europe, Latin America and Africa have competitive advantages in cheaper, faster-growing raw material. This always undercuts the Scandinavian forestry competitors.
However, UPM has taken the logical next step of building its new pulp mills in low-cost Uruguay and is moving away from simple commodities toward specialities such as wood-based fuels, and labels, where it is now the number two to competitor Avery.
It sources all its power from non-fossil fuel sources, such as hydro, nuclear and biomass, and is now the number-two power producer in Finland. Heavy investment has weighed on earnings, but should increasingly contribute in years to come. Its 4% dividend yield looks attractive.
Technip Energies: adapting to a decarbonised future
Oil services is another ghastly industry with a very chequered history and faces an uncertain future. However, Technip Energies (Paris: TE) has mostly refocused on building liquefied natural gas facilities, which are in very strong demand worldwide given the concerns in Europe about Russian gas supply. It took a big hit from the unexpected loss of Russia as a client, but replacement clients will pick up the slack in due course. These skills in engineering are also very applicable to all sorts of decarbonisation projects.
Meanwhile, its main competitor, Saipem, is struggling and may not survive without another massive capital injection. A newly initiated dividend of 3.75% is a good starting place for Technip.
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