Engineering group Melrose, a long-term favourite in the F&C UK Equity Fund, has become the latest in a series of companies to announce an increased dividend with a payout up 38%.  Others include GlaxSmithKline, Tesco and advertising group WPP all also held within the Fund.  This seems to be a clear theme across the market.  The question we are wrestling with is how this sits with comments from economists and the media of an increased risk of a double-dip recession and the S&P set to fall below 500! Our meetings with companies are not indicating to us that business activity has deteriorated markedly in the last six-months or so.

The results from advertising agency WPP also seem to support this business confidence with increased advertising revenue across their major markets, while in the US airlines added capacity in August for the first time in many months.

Years of experience tell us that finance directors do not like cutting dividends, so why are we seeing such a flow of increases when the economists seem to be preaching doom and gloom?

Furthermore, this is a trend not restricted to the UK, we are also seeing strong increases in Europe and in the US companies are also choosing to return money to shareholders, but via increased share buybacks.

Cairn Energy, another favoured stock in the F&C UK Equity Fund, saw its share price suffer when it announced the discovery of gas from the T8-1 well in Baffin Bay. Investors seem to be speculating that no oil would be found. But Cairn has said they have found “early indications of a hydro-carbon system”. Only time will tell. But let’s not forget that it took 17 wells before Cairn struck meaningful oil in India’s Rajasthan region and there the rest is history.

News from Tullow Oil that they have completed the purchase of the stakes Heritage Oil held in two shared licence areas in Uganda has been well received by the market.  This is part of a two-stage plan to develop the potential of the acreage in the licences held by Tullow.  This news was quickly followed by a positive announcement on the results from the Ngiri-2 appraisal well, 1.7km north or the original discovery, where oil was also found.  Further test drilling is underway to assess the full potential of the find.

We expect announcements on stage 2 of Tullow’s development of its Ugandan operations in the next few months.  This should see stakes in their licences sold to China’s CNOOC and to Total of France.  We believe that with the on-going discoveries and these industry experts on board, the potential output is materially over and above market forecasts.

Ghana has also provided good news fro Tullow with the results from the Owo-1 well, which found high quality light oil and the company believe the discovery could be as big as the Jubilee field, which has been a key driver of Tullow’s the share price in recent years.

I have a large position in Tullow in the F&C UK Equity Fund in advance of what I believe will be on-going positive newsflow over the coming months from their operations in Uganda, Ghana, West Africa and South America.

This further underpins our approach to the oil sector where for some considerable time we have avoided ‘big’ oil in favour of the growth potential of the exploration and production companies further down the market cap scale.

We have for some time being saying that the better quality companies have been very successful in strengthening their balance sheets since the worst of the credit crunch and deep recession.

In the last few weeks we have seen this balance sheet strength being put to work through a series of takeovers.  Today (21 July) saw the announcement of a £2.5 billion deal whereby household products group Reckitt Benckiser is set to acquire SSL, the maker of Durex and Scholl footcare products.  The F&C UK Equity Fund is a clear beneficiary of this move as SSL has been a long-term core holding.

This follows fast on the heels of the bidding war which saw power systems group Chloride agreeing to be acquired by Emerson Electric for £997m. Elsewhere the discussions between International Power and France’s GDF Suez seem to be back on, while BP has struck a £4.6 billion deal with Apache of the US for the sale of gas assets.

What this seems to demonstrate is a degree of confidence in the global economic outlook amongst companies across a range of industries but also a recognition that organic growth is hard to achieve. It also underpins our view that many companies remain attractively valued and we expect the increased level of M&A activity to continue.

Oil exploration and production company Bowleven has announced the results of appraisal drilling off the coast of Cameroon. The results from its appraisal well I-3 indicate a better than expected outcome as they found light oil in addition to the expected gas condensate. More information on this is expected in the next month or so after a series of flow tests. These results serve to underpin the current share price but we believe their is further significant upside potential from elsewhere within the Cameroon operations with news also coming from appraisal well I-F and the ‘Wildcat’ Sapele-1 oil exploration well in the near future.

Bowleven remains a strong proposition in both the F&C UK Opportunities and F&C UK Equity Funds.

These results also underpin our long held preference for the growth potential of the E&P stocks over the majors in the oil sector.

The appointment of new CEO Guy Berruyer at Sage was a key part of the investment thesis behind its inclusion in the UK Opportunities portfolio. Though an inside appointment he does have a good deal of previous experience at other companies. We believe that the change, which becomes effective on 1 October, will see a focus on margin improvement and will mean better growth prospects.

…in fact it is quite normal for this point in the investment cycle.

What this does mean is that from here any earnings upgrades will be a reflection of the quality of earnings and is likely to be limited to those companies which have control over their capital investment programmes.  As a result, stock-picking will become increasingly important.

The response of both sterling and gilts, post-budget, has been positive, which means that a number of the more domestically focused mid-cap companies may offer some opportunities. It is a matter of knowing where to look. For example, the low ticket items of Restaurant Group mean it is less likely to be affected by a slowing UK consumer than some of the big retailers.

Recent activity across the F&C UK Equity and F&C UK Opportunities Funds has focused on the quality of earnings.  For example, the UK Opportunities Fund recent closed out a trading position in African Barrick Gold. The proceeds were used to establish a position in pharmaceuticals group AstraZeneca, which has just won a court case in the US extending the patented life of its cholesterol drug Crestor, its third best seller, for a further three years.

Both Funds are now overweight pharmaceuticals with the UK Equity Fund holding GlaxoSmithKline and long-term favourite Shire, while the Opportunities Fund also owns AstraZeneca.

In addition to the quality earnings argument, these companies also provide an element of exposure to the consumer across the emerging economies, which look set to remain the main drivers of global growth.

At first glance it seems odd that BP’s share price bounced almost 10% in early morning trading (17 June) after it suspended dividend payments for 2010 (the first $2.6bn of which was due on 21 June), agreed to pay $20bn into a compensation fund and with its final liabilities still unknown. The current estimate of clean up costs from the US Coastguard Service is around $6.5bn, but it remains early days.

Positive developments
BP also announced that it is committed to restoring the payment of the dividend in 2011, though investors need to be aware that we do not know what the starting level of future payments will be. The contributions to the compensation fund will be $5bn in 2010 and then quarterly payments of $1.25bn spreading the liability.  They also announced they would be selling around $10bn of non-core assets.

These moves will hopefully be enough to quieten down the more extreme outbursts in the media so that the focus can return to what is really happening.  Here a second containment system is being launched which should increase the amount of oil and gas being recovered.  However, the big question remains the execution risk in capping the well as no one has tried to do it a mile below the surface before.

Probably one of the most positive changes has come in the tone from the White House, where President Obama said last night that

“…BP is a strong and viable company and it is in all our interests for it to remain so…”

Market Sentiment
At the moment market sentiment seems to be saying that the bulk of those forced to sell by the dividend issues have done so but that potential buyers are remaining on the sidelines until we get some more clarity.

The suggestion that BP could be going bust seems to me to be the final straw in what has clearly been a tragic situation. But our job as investors is to look through the political rhetoric and to try to get a grip on the underlying business fundamentals.  The latest suggestion that BP could go bust saw its share price in the US hit a 14 year low and sent it down to 350p at today’s (10 June 2010) UK opening.  This values BP at around $90 billion.  But BP has 18 billion barrels of ‘conservatively registered’ proven reserves, which means this oil is valued at just $5 per barrel and it completely ignores the estimated 63 billion barrels of ‘probable’ reserves.

BP is important to the US
BP is the largest producer of oil and gas in the US and is one of the US’s largest employers so it is not in the interests of the US to push it to the brink. And while the politicians are demanding a dividend suspension they seem to be overlooking the fact that some 40% BP shareholders are based in the US.

The dividend
It is the risk that the dividend will be suspended that has driven a number of European investors to sell, which has contributed to the fall in the price. But if it happens, it should only be a temporary measure.

The costs of the clean up will be spread
The costs of the clean up continue to mount and gyrate wildly depending on who you ask.  In reality they will only really start to become properly quantifiable once the leaking well has been capped.  But we should remember that while this will be a very big number it will be spread over many years as the range of claims are processed. Indeed, ExxonMobil were still dealing with claims 20 years after the Exxon Valdez ran aground in Alaska.

We don’t normally like big oil
We don’t normally like big oil in our growth funds because they have such limited growth potential, which has benefited the UK Equity Fund. But with valuations where they are we are taking a serious look at BP.

The earlier than expected announcement of Sir Terence Leahy’s retirement and replacement at the helm of Tesco came as a bit of a surprise but shows clear thinking behind the succession planning.  His replacement, Philip Clarke, is 50, which means he has a good tenure in front of him providing stability at the top. He has also been on the Board since 1998.  The fact that he was head of their international operations points to the long-term strategic direction of Tesco, which is still thought of by many as a UK retailer, rather than in its position as the world’s third largest retailer.

Another interesting development is a new role of CEO for Asia again showing the importance of this part of the world in Tesco’s strategy.  The post is filled by David Potts who has done a fantastic job overseeing the logistics operations in the UK.
 
This move also eases the pressure on the fledgling US Fresh & Easy operation (whose CEO Tim Mason has also been appointed Deputy CEO with responsibility for the global Tesco brand) and will potentially make it easier to withdraw from the US, if it does not prove successful.

Tesco remains a core holding in both my UK Equity Fund and Phil’s UK Opportunities Fund.

Is Dolphin Capital at a turning point?

Dolphin’s trading update on 8 June provided much welcome news for investors after a long wait. They announced that they had received final planning permits for two golf courses at their Venus Rock resort in Cyprus, probably Europe’s largest integrated seafront development.  This also means construction can now start on some 267,000sq m of residential space comprising 711 single units and six apartment buildings taking the resort’s total space to over 450,000 sq m.

Importantly, the funding for these developments is fully in place.

They also announced strong sales since their last trading update on 11 March 2010 including the first plots at their signature development in the Porto Heli Collection in Greece.

Again this stock is held by both the UK Equity and UK Opportunities Funds. 

We continue to like the investment thesis underpinning the mining sector and its clear and direct link to the long-term secular change underway in the emerging markets. But like all things it will not be a smooth ride.

In recent months I’ve changed tack a bit and switched out of industry heavyweights Rio Tinto and Xstrata and into a couple of smaller specialist operators, which is something UK Opportunities is able to do.  As such, I have added African Barrick Gold to the portfolio as a shorter-term trading opportunity.  They stand to benefit from the upward trend in gold prices, both fundamentally and as investors look to gold as a store of value in an uncertain world.

I’ve also added iron ore specialist London Mining as a long-term hold.  I know the company well and their first mine ‘Marampa’ in Sierra Leone is set to start producing ore in the second half of 2011 and they aim to move from producing 1.5m tonnes per annum to 25m tonnes per annum by 2015.  The management are also significant shareholders.

Au revoir rather than good bye
I’ve recently said au revoir to an old friend with the sale of Scottish & Southern Energy a backbone position since the launch of the Fund.  But currently I see better opportunity in National Grid and with similar ‘defensive’ characteristics in an uncertain world.

One for the future
One other point to note was the Fosters’ announcement in Australia of the separate listing of its beer and wine operations.  While a little way off, the beer business could be of interest to SABMiller.

Our new blog will give you a flavour of our thoughts and how this is being reflected in the portfolios of the retail funds and also to give some food for thought.
The market’s 10%+ correction since its 2010 high on 15 April has been driven by the fear of sovereign debt contagion leading to concerns that the euro and the monetary union are not necessarily the indestructible bonds that we once thought.

While the market has been led down by the miners following a period of stellar returns and concerns over the eurozone’s problems having a know-on impact on the global growth picture.  However, some of our more specialist plays fared better than the industry heavyweights.  Long time favourite Petropavlovsk (formerly Russian gold miner Peter Hambro) outperformed the mining sector by over 10% as the gold price continues to benefit from its safe haven status in uncertain times.
We continue to avoid mega cap oil with the UK Equity Fund completely out of BP and Royal Dutch Shell, where meaningful volume growth is very difficult to achieve favouring BG, Cairn and Tullow instead.

With the problems facing BP this has clearly been the right call.  But when the market marked the shares down significantly after the rig explosion in the Gulf of Mexico we did look at it feeling the reaction may have been too severe but decided to hold fire for a bit more clarity.  The risk for BP now is not the financial cost of putting the mess right but rather the longer-term reputational risk and damage to its brand, which could be significant.