Investment opportunities: Oil breaks through $50 a barrel

Emma Wall  |  01/06/2016Text size  Decrease  Increase  |  

Emma Wall: Hello and welcome to the Morningstar Series, "Why Should I Invest With You?". I'm Emma Wall and I'm joined today by Stephen Message, manager of the Old Mutual UK Equity Income Fund.

Hi Stephen.

Stephen Message: Hi there.

Wall: So let's talk about the oil price. Above $50 a barrel for the first time in 2016. What does it mean?

Message: Well it's interesting. At the start of the year the oil price, end of January, early February, the price went below $30. And I remember many commentators suggesting that we were going to fall to maybe to $10. And then I remember many years ago when the oil price was close to $140, we were talking about oil prices going to $200.

So it's really interesting I think how ultimately the price is quite self-correcting, ultimately lower prices force lower levels of investment and then supply demand comes back into balance. You are seeing that now slightly and general expectations for demand have improved a bit as well. So you are seeing the oil price recover to about $50.

Wall: And of course many of the mining companies have looked extremely attractive just based on yield. But that has been because their share prices have been so depressed. And people have been talking about whether their dividends are sustainable and indeed we've seen some companies actually come away from dividend table and stopped paying out haven't we. What does this higher oil price mean, does this mean actually we should be going back into miners?

Message: With the mining companies the dividend yields were very high and actually that was a signal that those yields weren't sustainable. So in the case of Rio Tinto (RIO) and BHP Billiton (BHP) we saw dividend cuts. So the stock market was actually sensing those dividends were going to be cut there. Actually, if you look at some other valuation measures, longer-term valuation measures such as price-to-book value, enterprise-to-sales, those valuations I think are quite attractive.

So actually I have been building positions in that area gradually, and I'm pleased to see the fact that commodity prices are starting to gradually recover, actually start supporting the dividends of those companies going forward. So actually I am starting to get more optimistic in as those commodity prices have started to recover.

Wall: So you do think perhaps that at this level the yields or the dividends rather are sustainable?

Message: Well given the magnitude of those dividends, the cuts that we saw, I do think they are from here, yes barring obviously another significant commodity price fall. What you saw at both of those companies do which I think is the right thing to do, is they moved away from a progressive dividend policy to one where the policy was much more a function of profits within the basis of payout ratios. Because ultimately if you are operating a cyclical business it is very hard to operate a progressive dividend policy absolutely into the future.

So I think the dividend policy is a lot more sensible now where it's much more derived from what's going on in profits. But I think from this level we look at the yields a bit further out that the yields they are offering I think are quite attractive.

Wall: Now I can't let you go--because you are a UK equity manager--without talking about Brexit. Of course that's the other thing, the other uncertainty on the horizon other than commodity prices. Has it affected the way that you are constructing your portfolio at all?

Message: We are approaching the referendum, now there's quite a lot of noise around it at the moment. If you remember a year or so ago we were worrying about the general election. And we have moved on from that now--I think it will be a similar case with the referendum. It has affected certain companies in the portfolio, particularly a number of companies, financially operating companies, domestic companies as well. We are of the view at Old Mutual, I am of the view anyway that actually we will remain and we've started to see some of those companies more exposed to Brexit scenario, saw their share prices start to recover.

A number of mid-cap companies have started to recover. And also within the currency as well, it has started to improve as well. So it's not without risk, I don't think the scenario will play out. You will still see some of those areas recover.

Wall: Stephen thank you very much.

Message: Thank you.

Wall: This Emma Wall for Morningstar. Thank you for watching.

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