Rio Tinto, Tesco and Reckitt Benckiser are among the large cap stocks that offer the greatest potential for dividend growth, according to Rathbones' Alan Dobbie.
A number of industry experts, including FE Alpha Manager John McClure and Standard Life’s Thomas Moore, have previously said that investors would be better off looking down the market cap scale for income given the lack of dividend growth potential in some of the larger UK stocks.
However Dobbie (pictured), who co-manages the five crown-rated Rathbone Blue Chip Income & Growth fund, says that although they are becoming harder to find, there are still many large cap stocks that can increase their payout to investors.
"Trying to find places to invest is harder at the moment. There are opportunities, but we used to have a much longer shopping list, now we just have two or three items on there," Dobbie said.
He told FE Trustnet what his most recent purchases were and why he is so optimistic over their long-term potential.
Rio Tinto
Dobbie says he started buying Rio Tinto in December and has been adding to the FTSE 100 miner ever since.
"The new management team are intent on improving the historically poor capital allocation record," he explained.
"This, coupled with a tight control on costs and improved efficiency, should lead to attractive cash generation and dividend growth potential."
"Rio Tinto has been through a lot over the last 10 years. On average, the cash-flow return on capital has been higher than the cost of capital, but over recent times that has changed," he added.
Rio Tinto has struggled recently. According to FE Analytics, it has lost money over one, three and five years.
So far this year, Rio Tinto has lost 21.97 per cent while the FTSE 100 index has returned 10.53 per cent.
Performance of stock vs index year-to-date
Source: FE Analytics
There is still a degree of scepticism surrounding mining shares, however. FE Alpha Manager Algernon Percy recently told FE Trustnet that investors should tread very carefully if they want to get into the sector.
While Dobbie admits there is business risk with Rio Tinto because it is very sensitive to macro conditions, he is a fan of the company because the management team is trying to strengthen shareholder relations.
"The major catalyst for change at Rio Tinto, along with the other mining companies we hold, has been management change. They have been paying higher dividends to shareholders and have been much better with their capital allocation."
"They now understand their responsibility, not only to shareholders, but to the price of the commodities they produce, as they have been guilty in the past of increasing volumes at the wrong times."
"There is talk of this change, but the actual evidence may take some time to come through."
"In Q4 this year, Rio Tinto have to make a decision regarding their 360 project in western Australia, which would see them increase capacity. It is very interesting as it is the first major test for the new management team."
"If they increase capacity, it could cause the price of iron ore to fall or they could just hold back," he added.
Rio Tinto currently has a dividend yield of 3.8 per cent. Our data shows that 151 funds in the IMA universe count Rio Tinto as a top-10 holding. These include the likes of Artemis Income and Liontrust Macro UK Growth.
Tesco
Dobbie says that Tesco offers investors both long-term growth potential and a progressive dividend, despite setbacks over recent years.
"The previous management team had underinvested in the UK business," he said.
"The new CEO is focused on fixing the UK business, retreating from non-core geographies and businesses and improving capital allocation. All of the above should improve shareholder value creation."
"Tesco has historically been seen as defensive stock, but it hasn’t been acting like that recently."
"We realise that re-invigorating a company like Tesco will be a multi-year process. The current dividend yield is 4.3 per cent and it is trading on 11.5x earnings."
"There is some similarity between mining companies and the UK food retail sector. They began massively increasing capacity but one day there wasn’t the need for such a huge amount of goods."
"They realise they can’t do that anymore and have sold assets around the globe. That capital discipline makes Tesco an attractive investment."
Tesco has lost money over three years and while the stock has returned 20.56 per cent over 12 months, it has still underperformed against the FTSE 100.
Performance of stock vs index over 1yr
Source: FE Analytics
There are 33 IMA funds that count Tesco as a top-10 holding. Among these are JOHCM UK Equity Income and the five crown-rated Invesco Perpetual Income & Growth fund.
Reckitt Benckiser
Julian Chillingworth, chief investment officer at Rathbones and co-manager of Rathbone Blue Chip Income & Growth with Dobbie, says he has recently bought consumer goods company Reckitt Benckiser because the management team is re-focusing the business model.
"Since the new management team at Reckitt Benckiser has come in, they have been concentrating much more on building their international businesses," Chillingworth said.
"They have been using annuities from their product Suboxone – which is a drug for heroin addicts – to drive the business."
"There have been concerns from the market about generic competition for the drug; however that will take some time to come through."
"Therefore, they will use the cash-flow they get from Suboxone to grow the company," he said.
"They are basically growing the pharmaceutical end of the business against their household products."
"They have been known for producing washing tablets and loo cleaner, but there is only so far you can go with those products," he added.
Reckitt Benckiser has a dividend yield of 2.96 per cent .
The stock has returned 54.33 per cent over the last five years compared with 32.38 per cent from the FTSE. However, that performance has tailed off recently, as the graph shows.
Performance of stock vs index over 5yrs
Source: FE Analytics
Reckitt Benckiser features in FE Alpha Manager Neil Woodford’s five crown-rated Invesco Perpetual Income and Invesco Perpetual High Income funds.
There are 36 other IMA funds that hold it in their top-10.
