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Income heavyweights trim Sainsbury's on merger risk

Income heavyweights trim Sainsbury's on merger risk

Clive Beagles and James Lowen have trimmed their JOHCM UK Equity Income fund's holding in Sainsbury's (SBRY) after a review of the supermarket's planned merger with Asda revealed more downside than expected to a rejection of the deal.

Beagles and Lowen have been strong backers of the UK supermarket sector in their £3.8 billion fund, with 1.4% of their fund held in Sainsbury's and 0.8% in Morrisons (MRW) at the end of June.

But in their latest update to investors, they said they reduce their weighting to Sainsbury's, although they remain 'overweight' the stock, holding more than the market weighting.

'Further analysis highlighted more upside than we expected should the deal with Asda be cleared by the Competition and Markets Authority (CMA), but also more downside should it be rejected,' they said.

'Given the current ongoing sluggish relative performance of the Sainsbury's stand-alone business, and with the share price already up 40% year to date due to the Asda announcement, we took the opportunity to rebalance our weighting.'

Plans for a sensational merger of Sainsbury's and Asda, the UK's second and third largest supermarkets, were announced in April.

The merger is likely to be subjected to tough scrutiny from the CMA, given it would create the UK's largest retailer. Analysts believe the regulator's approval of Tesco's (TSCO) acquisition of convenience store operator Booker last year had emboldened Sainsbury's, although most predict it will need to sell off a large number of stores to gain approval.

'As the CMA decision is unlikely to be announced before April/May next year, we will continue to monitor the situation,' said Beagles and Lowen.

AstraZeneca sale

The managers have also sold their stake in pharmaceutical giant AstraZeneca (AZN), a major holding that had accounted for 2.3% of the fund as recently as June.

Beagles and Lowen said the sale followed strong performance of the shares, which had driven down the yield. The shares are currently trading on a yield of 3.6%, broadly in line with the wider market.

'AstraZeneca is up 40% to 45% from its low point in August last year when one of its pipeline drugs had a poor data readout and was exited on a price-earnings ratio of over 20 times,' they said.

'This rotation out of low-yielding stocks into higher-yielding stocks is one of the drivers of fund dividend growth.'

Engineering group Keller (KLR), up 25% over the last 12 months and now yielding 3.4%, was also sold.

Forecast dividend growth for the fund was upgraded to between 12% and 13%, up from 9% to 10%. This was helped by growth from the likes of oil giant BP (BP) which in July reported its first dividend rise in nearly four years.

Beagles and Lowen also pointed to strong dividend growth from a number of the fund's other major holdings. Payouts are up by 19% at construction services business Morgan Sindall (MGNS), 15% at miner Rio Tinto (RIO) and 10% at insurer Aviva (AV).

This suggests a fund yield of 4.7% for 2018 and a prospective yield of 4.9% in 2019.

Green lights flashing

Value-focused investors Lowen and Beagles also struck an optimistic tone on the valuations of the sorts of stocks they like.

'Many of the valuation signals we look at are flashing green,' they said.

'After a period of sustained underperformance by "value" stocks versus "growth" stocks globally, the level of underperformance by "value" is now back in similar territory to where it was at the height of the TMT [technology, media and telecoms] bubble in 1999,' they said.

'As interest rates normalise and central banks’ balance sheets contract, we expect this trend to reverse.'

They pointed to the valuation of the stocks they hold on a 'price-to-book' measure, which was now near its lowest level since the market's 2009 trough following the financial crisis. Their discount to the wider market is meanwhile near its widest in the history of the fund.

'As ever, past performance is no guide to future returns, but both have tended to be good predictors of future unit price performance over the 14 years the Fund has been operational,' they said.

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