Problems with success in RIRP

Problems with success in RIRP

Problems with success in RIRP.  When I first began thinking about what I would write this time, I was hoping that I would at last be able to begin with the introduction I had planned for the moment the Rising Income Retirement Portfolio (RIRP) first became fully invested:

  • Dividends already announced for this year will way outstrip inflation
  • No major changes in the financial fundamentals are envisaged for any of my holdings, therefore
  • No action is needed other than to sit back and watch the rising income roll in.

Sadly, the day after this pleasant fantasy, point 2 was out with the news that BP had lost its latest court case over the Gulf oil spill and might now be facing damages of $15bn more than the fortune it has already provided for, and largely already paid out.

And though I was as always indifferent to the short-term knee-jerk share price reaction, I must ask myself whether this fresh potential blow could prejudice the further inflation-beating dividend growth on which my continued holding of the stock has been based.

Unfortunately, I haven’t a clue. For instance, I have been following tobacco shares for years, along with their endless court wranglings involving US smoker class actions, yet the ramifications of the American legal system remain a complete mystery to me – as I suspect they are for most Americans.

BP will of course appeal against this judgment. The test for me will be in the tone of BP’s third quarter dividend declaration, due at the end of October. Any hints that the current payout may not be sustainable will necessitate more emergency decisions of the sort I had hoped were now finally behind me. Even any indication that the scope for future payout increases might be prejudiced could well make me decide to part company.

Watch and wait at BP

I had toyed with the idea of switching my whole BP investment to Shell right away. This would entail only a small sacrifice in income, which happily I could now afford this year.

My concern over maybe being hasty in selling Balfour Beatty proved unjustified, as another profits waring this week confirmed, but I have decided to wait and see what BP’s October statement brings.

I am also mildly encouraged by the fact the company has continued to find the cash to continue its share support programme, even though I personally regard such repurchases as a huge waste of shareholders’ money: I would prefer to see any “spare” cash paid out in cash dividends.

What BP has spent in share support since the US court announcement could have paid for an extra rise of over 4% in the dividend.

And this would have been useful. The RIRP’s actual income from BP continues to be bedevilled by the inevitable currency effect for a company which accounts and determines its dividends in US dollars – quite rightly given the source of most of its profits. So although the most recent quarterly dividend is unchanged in US dollars at 9.75 cents, the recent weakness of sterling has transformed this into a 2.6% sterling increase for the quarter. But despite this, for the past four quarters the overall strength of sterling has almost exactly wiped out the 6.9% by which the company raised its dollar dividends. My only consolation is that I would have the same currency distortion problem with Shell.

Problems with success:
Problems with success: The distortion of special dividends

Latest dividend increases are good

Superficially, though, the fund’s position is strong enough to withstand any BP squalls.
Since the beginning of July, 8 of the RIRP companies have announced dividend increases, and they average no less than 12%. Their dividends themselves are shown in blue in the table, unless the companies have both announced increases and already paid them out in the last quarter, in which case it is the “dividends received” figures which are in blue. Two of them, BT and L&G, have made us wait a few days longer than I would have expected based on last year’s timetable,

These announcements are the basis of the projected income for year 7, to the end of February 2015, will now be very nearly 7% higher than last year, even after reversing some of the questionable accounting I employed last year to keep my yearly performance ahead of inflation. This compares with the current RPI inflation of under 2.5%. I remind you again that technically I did not need to don the hair shirt, since cumulatively the fund’s dividend growth since launch is more than double inflation, but obstinacy made me keen to claim inflation-busting income increases for every single year, not just cumulative ones.

So does anything else need to be said? Can we just sit back and watch the dividends roll in? Sadly, maybe not, but that is one of the problems with success.

In some ways my emergency surgery following Balfour Beatty’s profit warning may have been too clever. The first dividend from Infinis has provided a one-off boost, and I also received a further unexpected bonus from a second special dividend from Direct Line.

Problems with success of the RIRP
Problems with success of the RIRP

But while I am loath to look gift horses in the mouth, the fact that Vodafone’s massive special dividends this year will not be repeated next year poses a challenge in continuing to deliver a rising income on a year-to-year basis. As I have said before, in theory we should all be banking these special payments and saving them for a rainy day, but I have been around too long to trust in the triumph of my own good intentions over experience.

More specials ahead

I have tried to show the effect of these special payments, shown in yellow in the graph. Last year our income was boosted by a very useful special payout from Standard Life, which I am therefore showing on the minus side of the graph. This year our actual income from the company will be nearly halved, though the underlying regular dividends have been raised by over 7%, as shown in blue on the graph.

The Vodafone special payment represents the equivalent of organic dividend growth for the entire RIRP of over 7%. It is quite possible the portfolio will achieve this again next year, and maybe more. This, though, assumes the continuation of big special payments from Direct Line. I am encouraged by their announcement in September that they would return to shareholders the bulk of their £160m profit on the sale of their international operations: I reckon this to be worth another 8p per share “special”.

There is also a chance that Lloyds may finally resume payments, but I have been hoping for this for longer than I care to remember so I am not holding my breath; nor for RSA, even though the only reason for continuing to hold it is the expectation that it will come back to life sooner rather than later: but it would be unwise to assume it will be next year. Here are two examples of problems with success.

Maybe I worry too much. Perhaps I should reflect more on the fund’s achievements, which are substantial. Over its 7-year life the yield on my original investments has grown some 70% from the initial target of 4% to nearly 7%, way ahead of the cumulative rise in the cost of living of under 25%.

When a company like SSE looks like a laggard for “only” raising its dividends this year by a touch more than the RPI, I realise my problems are essentially those of success. My investment freedom, should I want to make changes, is only constrained by the difficulty I would face in achieving comparable yields to the mouthwatering returns I am getting on my originally invested capital. Perhaps these are not bad problems to live with.

First published in The IRS Report on 4th October 2014.

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