The Income Investor: lower rates to boost this stock’s dividend
Falling interest rates mean the outlook for this sector should become increasingly upbeat. Analyst Robert Stephens likes this company’s scope for brisk dividend growth, solid financial position and improving operating environment.
11th September 2024 12:25
by Robert Stephens from interactive investor
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The beginning of a new era of interest rate cuts is highly significant for income investors. Not only does it mean that the appeal of cash is set to gradually decline, it also equates to a far more upbeat outlook for dividend stocks.
Indeed, the Bank of England is widely expected to persist with monetary policy easing despite inflation moving 20 basis points above its 2% target in July and it being forecast to rise to 2.75% by the end of the year.
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According to forecasts, Bank Rate is due to fall from its present 5% level to 4.2% over the next year before declining to 3.8% by the third quarter of 2026. Its fall is set to have a positive impact on the UK economy’s growth rate that gradually filters through to the financial performance of domestically-focused companies. In turn, this should provide greater scope for dividend growth over the coming years.
A positive impact on property stocks
Of course, a sustained fall in interest rates over the medium term will inevitably have a greater impact on some sectors than others. The commercial property sector, for example, should be a major beneficiary of an increasingly loose monetary policy.
Property valuations across the industry have been negatively impacted by a period of elevated borrowing costs that prompted a decline in demand. This led to share price falls among property stocks, with investors seemingly factoring a continuation of recent downward portfolio valuation trends into share prices.
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A restrictive monetary policy also brought the threat of greater default rates among property firms and the prospect of growing bad debt provisions. Furthermore, it put pressure on profitability across the sector as incumbents experienced rising interest costs on some or all of their debt at the same time as rental growth stalled.
Income investing potential
While a full reversal of the aforementioned trends may take time to come to fruition due to the presence of time lags following changes to Bank Rate, falling interest rates mean that the outlook for UK-focused property stocks is set to ultimately become increasingly upbeat.
As a result, FTSE 350 property stocks have significant long-term appeal from an income investing standpoint. Weak investor sentiment over recent years has meant that in many cases they currently have attractive dividend yields that are well in excess of those offered by the wider index.
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Alongside enticing income returns, improving operating conditions for property companies mean the prospects for dividend growth are likely to significantly improve. And with UK-listed real estate investment trusts (REITs) being obliged to pay out a large proportion of their property income profits as dividends, an improvement in their financial performance should directly filter through to shareholders in the form of a rising income.
Yield (%) | ||||||||||||||
Asset | Current | 31-Jul | Change (end Jul-current) % | 09-Jul | 05-Jun | 09-May | 09-Apr | 11-Mar | 09-Feb | 03-Jan | 04-Dec | 06-Nov | 09-Oct | 03-Sep |
FTSE 100 | 3.72 | 3.69 | 0.8 | 3.72 | 3.70 | 3.66 | 3.74 | 3.90 | 3.92 | 3.82 | 3.94 | 3.98 | 3.90 | 3.92 |
FTSE 250 | 3.70 | 3.59 | 3.1 | 3.72 | 3.77 | 3.80 | 3.86 | 3.89 | 3.94 | 3.82 | 4.05 | 4.13 | 4.26 | 3.95 |
S&P 500 | 1.61 | 1.63 | -1.2 | 1.59 | 1.65 | 1.70 | 1.75 | 1.76 | 1.82 | 1.94 | 1.99 | 2.09 | 2.13 | 2.03 |
DAX 40 (Germany) | 2.98 | 2.95 | 1.0 | 2.94 | 2.97 | 2.90 | 2.89 | 3.07 | 3.20 | 3.22 | 3.28 | 3.51 | 3.50 | 3.35 |
Nikkei 225 (Japan) | 1.74 | 1.60 | 8.7 | 1.54 | 1.61 | 1.60 | 1.52 | 1.55 | 1.64 | 1.80 | 1.80 | 1.85 | 1.92 | 1.84 |
UK 2-yr Gilt | 3.802 | 3.815 | -0.3 | 4.142 | 4.379 | 4.335 | 4.218 | 4.227 | 4.569 | 4.135 | 4.565 | 4.734 | 4.864 | 5.000 |
UK 10-yr Gilt | 3.773 | 3.970 | -5.0 | 4.141 | 4.214 | 4.175 | 4.040 | 3.970 | 4.064 | 3.673 | 4.174 | 4.381 | 4.555 | 4.410 |
US 2-yr Treasury | 3.571 | 4.354 | -18.0 | 4.635 | 4.787 | 4.853 | 4.747 | 4.538 | 4.486 | 4.364 | 4.604 | 4.941 | 5.081 | 5.031 |
US 10-yr Treasury | 3.616 | 4.103 | -11.9 | 4.292 | 4.344 | 4.510 | 4.378 | 4.098 | 4.177 | 3.986 | 4.245 | 4.654 | 4.795 | 4.300 |
UK money market bond | 5.22 | 5.29 | -1.3 | 5.32 | 5.19 | 5.22 | 5.25 | 5.30 | 5.25 | 5.26 | 5.30 | 5.24 | 5.19 | 4.96 |
UK corporate bond | 5.81 | 5.83 | -0.3 | 5.86 | 5.81 | 5.76 | 5.82 | 5.80 | 5.60 | 5.85 | 5.90 | 5.63 | 5.75 | 5.48 |
Global high yield bond | 6.68 | 6.73 | -0.7 | 6.85 | 6.83 | 6.75 | 6.90 | 6.90 | 6.90 | 8.73 | 7.00 | 7.40 | 7.07 | 6.99 |
Global infrastructure bond | 2.24 | 2.30 | -2.6 | 2.44 | 2.39 | 2.37 | 2.43 | 2.42 | 2.45 | 2.37 | 2.46 | 2.46 | 2.64 | 2.80 |
SONIA (Sterling Overnight Index Average)* | 4.95 | 5.200 | -4.8 | 5.200 | 5.200 | 5.200 | 5.304 | 5.328 | 5.324 | 5.323 | 5.349 | 5.365 | 5.4119 | 5.5711 |
Best savings account (easy access) | 5.20 | 5.20 | 0.0 | 5.20 | 5.20 | 5.20 | 5.20 | 5.20 | 5.20 | 5.22 | 5.22 | 5.20 | 5.30 | 5.00 |
Best fixed rate bond (one year) | 5.00 | 5.40 | -7.4 | 5.26 | 5.22 | 5.20 | 5.18 | 5.28 | 5.20 | 5.50 | 5.80 | 6.05 | 6.12 | 6.20 |
Best cash ISA (easy access) | 5.00 | 5.20 | -3.8 | 5.20 | 5.17 | 5.17 | 5.17 | 5.11 | 5.09 | 5.11 | 5.11 | 5.50 | 5.00 | 4.75 |
Source: Refinitiv as at 11 September 2024. Bond yields are distribution yields of selected Royal London active bond funds (as at 31 July 2024), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 9 September. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (9 Sep). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 11 September.
Potential threats
Of course, some property stocks have weathered a period of restrictive monetary policy better than others. Investors should be wary of firms with excessive borrowings even ahead of a forecast brisk decline in interest rates. While Bank Rate is forecast to fall by around 120 basis points over the next two years, its decline would still mean it is around 370 basis points higher than it was in 2021. Property firms that are yet to refinance large amounts of their debt could still end up with constrained profit growth, and a lack of dividend increases, if their interest costs surge higher.
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Investors should also be aware of vastly differing prospects for firms within the property sector. For example, companies with substantial amounts of retail or office units within their portfolio may struggle even as falling interest rates catalyse the economy’s growth rate. Changing consumer trends could mean that property firms which focus on areas such as online retail, in the form of warehousing and logistics assets, are better placed to generate rising profits and higher dividends.
Improving financial performance
Urban Logistics REIT Ord (LSE:SHED) is well placed to deliver an attractive income return over the long run. It currently has a dividend yield of 6.4%, which is around 310 basis points higher than the FTSE 250 index. Its yield has risen largely because of a sharp decline in its share price over recent years rather than a rise in dividend payments.
Indeed, shareholder payouts have been kept at the same level in each of the past four years. Its shares, meanwhile, currently trade roughly 40% lower than the all-time high they reached in April 2022 as investors have become increasingly downbeat about the company’s prospects.
However, the last mile logistics specialist’s latest annual results showed it is making encouraging overall progress. It reported a rise in net rental income of 8.4%, with the firm noting that its operating environment improved in the latter part of the year. This helped to reduce its vacancy rate from 7.4% to 5.8%. It also limited the decline in the company’s net tangible assets per share, which fell by just 1.3% after the firm experienced a resilient year-on-year portfolio valuation.
Growth opportunities
Alongside its attractive yield, the firm’s dividend growth prospects are increasingly upbeat. While falling interest rates are set to boost its financial performance, its focus on logistics assets is also likely to prove beneficial.
Although there was a decline in the proportion of retail sales conducted online after Covid-19 lockdowns ended, the figure has risen year-on-year in each of the past four months. It would be wholly unsurprising for the longstanding pre-pandemic trend towards digital sales to continue over the coming years. Given that six of the company’s 10 largest tenants are logistics companies, it is well placed to capitalise on growing demand for deliveries from online orders within the UK retail sector.
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Urban Logistics REIT’s financial performance may also benefit from a lack of suitable land for warehouses, particularly in and around urban locations. When combined with competing interests from residential property, a lack of supply of logistics assets may allow the company to command higher rents – especially as interest rate cuts have a positive impact on the economy and prompt higher demand for such locations.
A favourable risk/reward opportunity
The company’s solid financial position means that it is well placed to overcome short-term economic uncertainty. For example, it has a modest loan-to-value (LTV) ratio of 29% that is slightly below its target range of 30-40%. Its debt, meanwhile, has a weighted average maturity of over five years. This means it is unlikely to refinance all of its debt while interest rates remain at their current high level.
Additionally, the firm’s solid balance sheet provides scope to capitalise on low valuations within the property sector. While the company has typically used equity raisings to grow its portfolio in the past, it could realistically raise debt levels to do so in future.
Trading on a price-to-book ratio of just 0.75 (below 1.0, which value investors look for), Urban Logistics REIT offers a wide margin of safety. Perhaps more importantly for income investors, though, its low valuation means it offers an attractive dividend yield relative to the wider stock market. When combined with its scope to generate brisk dividend growth, a solid financial position and an improving operating environment, the stock appears to offer a favourable risk/reward opportunity for income seekers on a long-term view.
Robert Stephens is a freelance contributor and not a direct employee of interactive investor.
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