FirstGroup disaster in RIRP

Dealing with the RIRP’s FirstGroup disaster

FirstGroup disaster in RIRP. I had frankly been dreading writing this latest update to the Rising Income Retirement Portfolio, ever since FirstGroup ruined my cornflakes at the end of May with the announcement not only of their widely anticipated rights issue, but also suspension of their dividends, effectively for a year and half. But at least it makes a change from my usual complacent boasting about how my dividends continue to outstrip inflation.

I could have coped with the rights issue — and had planned to; but the dividend holiday means FirstGroup cannot have any place in a portfolio designed to produce a rising income with as little management as possible.

My immediate problem is the gaping £600 hole in my projected income for the year ahead — representing over 0.6% of the value of the total funds invested. I explained in the web updates and in last issue’s brief update that as I cannot afford to wait for the company to resume its dividends, the portfolio would sell half the holding the Thursday before the shares went ex-rights on June 10th, and the remainder the week afterwards, together with the rights if they had any value.

Although there was in fact little difference in the overall pre-cum and post-ex rights values, the weak stockmarket ahead of the second sale served to increase my overall losses to £5,036.03 from the original cost of £7,999.15.

With nearly two thirds of original investment gone to money heaven, and since this was also the highest potential yielder of my selections, it is sadly clear there is no realistic way any reinvestment can hope to make up the lost ground in the short term.

Of course I could claim I don’t really need to, because over the portfolio’s life the average projected dividend yield on the sums invested is 50% higher than my original target of 4%, which is more than double the rise in inflation for the period.

But I won’t. Instead I will use the crisis as a challenge to address one of the problems of success somewhat earlier than I had anticipated: unrealised capital profits. I have stressed many times that the capital performance of the shares is of almost no interest to me. I should have qualified that: unless they stop paying rising dividends and I have to crystallise a loss.

Which way to plug the FirstGroup hole?

My average mouth-watering 6% yield on my original investment means almost anything I do now is bound to further reduce the average yield on the fund in the short term. My first inclination was to mitigate the impact by going for a replacement share with a relatively high yield, but still with prospects of dividend increases at least matching future inflation.

But the Editor has pointed out that — given the inevitable short-term reduction in overall yields — now might be the time to crystallise some of my fortuitous capital gains and buy a lower yielding share with higher dividend growth prospects.

It is indeed true that four of my shares have doubled in value, and so now “really” yield less — on their market value — than my minimum yield criterion, which inflation has increased from its initial 4% to nearly 4.8%.

My first response was to remind him of the length of time it takes for a low yielding share to catch up with a higher-yielder. But on consideration, as always he has a point. So just as I included Bankers Investment Trust at his suggestion as a useful control to ensure I was not reinventing the wheel, I now propose to reinvest into both a higher yielding share, and into a “growth” share whose initial yield falls below my normal yield criteria.

Two sales to boost yield

So I am adding to my distress FirstGroup sale proceeds with the sale of one fifth of my holdings of Bankers Investment Trust, currently yielding well under 3% on its market value, and Pearson, now yielding under 3.7% to new investors.

For my higher-yield purchase, I am buying three £1,000 units of Direct Line, a company I would not otherwise have included, largely because together with my holding in RSA it leaves me uncomfortably overweight in the insurance sector. Direct Line are on a historic yield of 5.2% with a commitment to “increase the dividend annually in real terms”.

 

FirstGroup disaster in RIRP
Will Reckitt pay for dinner?

For the lower yielder I first considered Unilever, makers of many of the brand names you see on the supermarket shelves. But ever since they adopted the euro as their base accounting currency some years ago, sterling holders have been exposed to fluctuations in the exchange rate: so last year’s 8% rise in the euro dividend was pared to a rise of under 2% in the sterling payout.

So I am going instead for their main competitor in the household products sector, Reckitt Benckiser, whose brand names include most letters of the alphabet, including the best known brand of contraceptives. This combination has driven dividend growth of 67% over the past 5 years, bettering my own average, though the annual growth rate has slackened in recent years.

Another BP top-up

Elsewhere I am also topping up the BP holding with a further £1,000 purchase. Sadly their most recent payment suffered from the Unilever currency effect: a maintained dividend in US$ terms, the accounting currency which befits this largely US company, produced a slight reduction in the sterling payout received in June.

Reduced dividends are shown in italics in the table, somewhat unfairly putting BP in the company of recent dividend slashers RSA.

The FirstGroup failure disguises the underlying strength of the rest of the portfolio. Increased payouts and forecasts from nearly all the other holdings would have almost made good the £600 black hole by year end.

But the net reinvestment effect of my changes leaves my projected return on capital for the year currently showing a fall, partly because my capital profits do not fully offset the FirstGroup losses, and partly because we have already missed the bigger dividends paid earlier this year by the two new purchases.

FirstGroup disaster in RIRP
The Rising Income Retirement Portfolio to date

Although we are only one third of the way through the accounting year, dividends received to date are much more than one third of what I will need to restore my overall return on capital to the 6.3% which will probably be needed to beat inflation by my year-end. But the uneven pattern of dividend payouts means it is unlikely, but not entirely impossible, that dividend rises yet to be announced for the rest of the year will meet the fund’s yield target.

In which case, now that I have been forced to crystallise some of my fortuitous capital gains, I have set a precedent I may have to revisit next January.

First published in The IRS Report on 6th July 2013.

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