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Investors’ Chronicle: Aviva, Polymetal, Travis Perkins

BUY: Aviva (AV.)

Flush with cash after finishing its fire sales, the insurer plans to hand back £3.75bn in a “B” share scheme, writes Julian Hofmann.

The pressure was always going to be on management at Aviva to come up with a sure-footed way of rewarding shareholders after a number of disposals completed during the year left the company with a significant cash bounty. With activist investor Cevian Capital glowering in the corner, Aviva’s management had to grab control of the agenda with some eye-catching initiatives, and they did not disappoint.

Cevian had demanded a £5bn return of capital to shareholders before these results. In what looks like a compromise solution on the part of chief executive Amanda Blanc, Aviva will combine a total capital return of £4.75bn, with a hefty hike in the dividend this year, in a bid to satisfy the market. The announced £3.75bn in capital return, along with its existing £1bn programme brings Aviva close to the magic £5bn number.

The distribution will be via a “B” share scheme where shareholders will receive one “B” share for every ordinary share, which will then be redeemed at £1 each. Furthermore, the company plans to consolidate its shares and it will explain how this will work in a forthcoming circular. The other component of the buyback was a major hike in the dividend planned for this year. Blanc forecast that the dividend would rise to 31.5p a share this year, and 33p a share in 2023, representing a more than 40 per cent increase on this year’s payment.

While Aviva has been all about downsizing in recent years, it did unveil an acquisition in these results with the purchase of Succession Wealth for £385mn, which will fit in with Aviva’s wealth management division. Aviva sees the wealth management sector in the UK as a key driver of growth in the coming years as rising numbers of retirees take up their pension entitlements. The acquisition was funded from generated capital and will have an impact on the Solvency II, bringing this down to a pro forma 186 per cent, but it will add around £24mn immediately in cash profits.

You cannot fault the ambition from Aviva, which is targeting an annual capital generation figure of £1.5bn from its Solvency II position. Activist pressure may have played a role in how the company has designed its payout programmes, but this was the first set of results in some time that showed a fresh start for Aviva after years of underachievement. With the prospective dividend yield topping 7 per cent at current levels, the company is doing its best to become an income-seekers’ favourite.

HOLD: Polymetal (POLY)

The group’s chief executive has sounded a cautious tone on paying out a dividend given the invasion of Ukraine, writes Alex Hamer.

Russian companies are stuck between the motherland and the financial centres that have provided billions in capital over the past few decades. Polymetal, a gold miner, shows this starkly. The company said it was “appalled” by the “events going on in Ukraine” at its 2021 results announcement.

While less forthright than Shell and BP statements that specifically talked about Russian aggression, the miner went further than fellow London-listed Russian companies Evraz and Polyus, both of which said in their results announcements this week that they would continue to monitor the geopolitical events.

Polymetal’s market capitalisation has plunged almost 80 per cent — seeing it falling out of the FTSE 100 at the next rearrangement — since the invasion as investors sought to get rid of Russian holdings. Questions also remain about its ability to actually pay the dividends announced in this week’s results, given the ever-growing list of sanctions against Russian entities. Always a strong yield company, Polymetal said its final 2021 payout would be 52¢ a share, taking the total dividend to 97¢, compared with 129¢ in 2020.

The company said there had been no indications from Euroclear, the company that handles the distributions, that the 2021 final dividend payment could not go ahead, although chief executive Vitaly Nesis said Polymetal would reserve the right to suspend or cancel the payout should conditions change.

He was more bullish on actually facing sanctions, saying this was “low on the list” of risks facing the miner.

At the top of this list was getting supplies that are currently imported. Nessis said domestic gold and silver bullion buying would be enough to maintain sales, however. Polymetal will receive payment in roubles for this gold, which introduces further uncertainty: in the past week, the price of gold in roubles has climbed by over a quarter given the currency’s depreciation against the US dollar. Nesis said this differential could pose a risk to the dividend as well.

Capital and operating cost guidance for this year has been suspended, and the company will review projects less than 20 per cent completed.

We have had Polymetal as a buy for years given its dividends and stable output. Even if we were to ignore the war, these both look at risk (for London buyers, at least) and therefore we drop to hold, with a likely shift to sell if sanctions are ramped up or the dividend is cancelled.

HOLD: Travis Perkins (TPK) 

The supplier of building materials has dramatically scaled back its operations, writes Jemma Slingo.

Travis Perkins had a busy year in 2021. In April, the supplier of building materials demerged its Wickes business after a string of Covid delays. A month later, it sold its plumbing and heating division for £325mn in a bid to simplify the group. Its efforts seem to be paying off: like-for-like revenue is up across its core divisions and profit margins are improving.

Travis Perkins supplies both trade professionals and self-builders. In 2021, its merchanting business increased revenue by 25 per cent compared with 2020. More importantly — given the impact of the pandemic in 2020 — sales are also 3 per cent ahead of 2019.

So far, the group seems unfazed by inflationary pressures. Management said its merchanting arm has managed the challenges “extremely well”, using its “extensive supply chain expertise” to maximise product availability. Their optimism aligns with the profit figures: adjusted operating margins in the merchanting division have risen from 5 per cent to 8.4 per cent year on year.

Analysts are more struck by the performance of Travis Perkins’ retail arm, Toolstation. Its UK operating margin reached 6.3 per cent in 2021, higher than Liberum’s 5 per cent estimate. Analysts said this suggests profitability is improving faster than expected as the network matures.

And it is maturing. Toolstation has more than doubled its revenue in the last three years and a further 60 branches are expected to open in 2022. However, total operating margins are still extremely low at 2.9 per cent. Meanwhile, return on capital employed (ROCE) — which compares operating profit with the money invested — sits at just 4.5 per cent, up from a dismal 1.8 per cent in the previous year.

Adjusted operating profit across the group as a whole reached £353mn in 2021. This was around 5 per cent higher than analysts’ estimates. The group was given a boost by additional property profits, after vacating freehold and leasehold sites as part of its restructuring plan. Total property profits amounted to £49mn.

Indeed, Travis Perkins’ results are filled with one-off perks. Proceeds from the sale of the plumbing and heating business were returned to shareholders, for example, in a special dividend of 35p in November 2021. Meanwhile, management has extended its share buyback programme by £70mn, taking the total to £240mn. 

The question is whether Travis Perkins’ core activities can deliver strong returns going forward. There are a number of encouraging signs. For now, however, margins are still tight and Toolstation’s ROCE remains weak.

Chris Dillow: Aim’s strange reversal

It’s been a bad time for investors in Aim stocks. In the past six months the FTSE Aim index has lost more than 20 per cent while the All-Share index has moved sideways. This development is both odd and normal.

It’s odd because Aim shares have fallen in circumstances in which they have often done well in the past. There has been a tendency for Aim to outperform the All-Share index when sterling rises; when commodity prices rise; when inflation expectations rise; and when the FTSE 350 low yield index does well. There’s a simple reason for this. Aim shares are riskier than others and so benefit more than others when appetite for risk rises — which often happens during a cyclical upturn which sees commodity prices and inflation expectations rise.

Even before Russia invaded the Ukraine, however, we saw Aim shares underperform the main market despite support from these forces.

In part, there’s a simple explanation for this — albeit an odd one. Aim’s underperformance of the All-Share index has been exacerbated by the fact that the All-Share index has been flattered by the good performance of a handful of huge companies.

Shell and HSBC have both risen more than 30 per cent in the past six months and even BP is still 18 per cent up despite its loss from selling its stake in Rosneft. This means the index has outperformed most stocks.

In this sense, Aim has underperformed for the same reason that almost all fund managers have: in the past six months only 10 actively managed unit trusts in Trustnet’s database of all companies funds have outperformed Scottish Widows UK tracker and only two have beaten Vanguard’s FTSE 100 tracker. If we compare Aim shares with the FTSE 250 or small cap index, the underperformance is smaller — although still significant.

So far, so strange. In another sense, though, Aim’s recent underperformance represents a return to normality. My chart shows the point. It shows a long-term downward trend in Aim shares relative to the All-Share index. In the past 20 years the FTSE Aim index has given a total return of just 2.3 per cent a year — only 0.1 percentage points better than inflation. During this time the All-Share index has returned 6.4 per cent a year.

To put this another way, since January 1998 the Aim index has had a beta with respect to the All-Share index of one: Aim shares are riskier, but their risk is not only market risk. But they’ve had a monthly alpha of minus 0.2 per cent, implying that they underperform the All-Share index by 2.4 percentage points a year.

Recent events, therefore, fit the long-term pattern. But why is there such a pattern?

One reason lies in something we know from betting on horses and football. It’s the favourite-long-shot bias. People make too many long-odds bets and so lose more money than they would if they backed favourites. They value the small chance of a big pay-off more than the large chance of a modestly decent one. This leads them to buy speculative stocks which have a small chance of becoming tenbaggers. In this sense, the poor long-term performance of Aim shares is the counterpart of the good long-term performance of defensives.

There’s something else — overconfidence. Aim shares tend to be highly valued: the dividend yield on them has averaged 1 per cent a year in the past 20 years compared with 3.5 per cent on the All-Share index. Such high valuations can be sustained only by expectations of high earnings growth. But investors are overconfident about their ability to predict this: as Alex Coad and Paul Geroski have shown, longer-term corporate growth is largely random. This means Aim shares are more likely to give disappointing earnings news.

Herein, however, lies a ray of hope for Aim investors. In the past few years Aim’s underperformance has stopped: in fact, it has slightly outperformed the All-Share index since early 2015. This isn’t terribly impressive: given their greater risks (such as the tendency to do badly in recessions) Aim stocks should outperform on average. But it might just be evidence that investors have wised up to the mistake they made in the 1990s and 2000s of paying too much for speculative shares. Investors do sometimes learn.

If this is the case, then there’ll come a time when Aim stocks will outperform the All-Share index. This, however, requires that investors’ appetite for risk increases — and predicting when this will happen is difficult. Doing so is a bet I am happy for others to take.

Chris Dillow is an economics commentator for Investors’ Chronicle

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