Shires Income

Shires Income

Disclaimer
This is a non-independent marketing communication commissioned by abrdn. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Overview
SHRS’s differentiated approach to income offers a high and resilient yield, coupled with the potential for growth…

Overview
Shires Income (SHRS) is an income-focussed product led by managers Iain Pyle and Charles Luke, who strive to deliver a higher income than the market, together with the potential for income and capital growth. They invest primarily in UK equities, targeting companies they deem to be high quality because, in their view, these businesses tend to produce more resilient earnings streams with fewer tail risks. Additionally, the managers will invest overseas for opportunities that underpin their pursuit of delivering a high and growing income, as well as bolstering the resilience of the portfolio’s income streams, including Mercedes-Benz, which they invested in recently (see Portfolio). The board is seeking shareholder approval to raise the limit on overseas stocks to 20% from the current 10%, in order to allow the managers greater flexibility to achieve their objectives.

One distinguishing feature of SHRS is the managers’ decision to allocate around 20% of the portfolio to preference shares (see Dividend). With an average a yield of 7.5%, these shares do a lot of heavy lifting on the dividend, affording the managers greater flexibility to explore parts of the market less common in traditional equity income portfolios. This includes small- and mid-caps, which sometimes exhibit lower starting yields but offer greater dividend growth potential. This is an area of the market where the managers are finding increasing value, amidst attractive valuations, and have added several stocks, including Kier Group. Moreover, following the combination of SHRS with abrdn Smaller Companies Income Trust plc (aSCI) in December 2023, the managers’ direct exposure to small- and mid-caps has increased. Out of aSCI’s portfolio of 50 to 60 stocks, eight were carried over to SHRS post-combination, including 4Imprint, Hunting and Hollywood Bowl.

At the time of writing, SHRS is trading at a Discount of 9.6%, much wider than its five-year average of 4.2% and the AIC sector average of 5.9%.

Last year’s fully covered dividends give an historic yield of 6.0%, with the final dividend for the 2024 financial year of 4.8p bringing the total payout to 14.4p, an increase on the previous years’ dividend of 1.4%.

Analyst’s View
We believe SHRS is positioned well to deliver on its objectives of a high and growing income, alongside capital growth. The managers seek to diversify the underlying income streams utilising a mixture of investments in high-quality UK businesses, overseas opportunities the UK market may be lacking and an allocation to preference shares (see Portfolio).

In our view, the allocation to preference shares means the managers are less constrained from an income perspective and have greater flexibility to explore beyond traditional high-income UK investments. This approach allows them to consider businesses with lower initial yields but greater potential for dividend growth, offering something different versus many in the peer group. Balancing these types of companies has helped SHRS retain a yield premium to the market, enhance its income diversification and dividend growth potential, as well as bolstered its resilience during periods of market stress.

Despite facing increased competition from the high interest rates that investors can earn on cash over the last few years, the managers’ differentiated approach to income has buoyed SHRS’s Dividend yield, which at 6.0% remains attractive versus cash. We also think that the managers’ focus on high-quality companies, overseas exposure and allocation to preference shares provides investors both growth potential and protection against inflation that are often lacking with cash. Additionally, the fact that SHRS is currently trading at an abnormally wide Discount could present a potentially appealing entry point for investors. A rebound in Performance and strengthening investor sentiment towards UK equities could see it narrow quickly, providing an additional boost to returns.

Bull
Successful combination with aSCI has reduced costs, increased net assets and led to more focussed exposure to small-caps
Offers one of the highest yields in the sector and a premium to the market, supported by a range of income streams and strong reserves
Discount exceeds its own five-year and peer group average, which provides an attractive entry point for new investors

The managers also argue that the 20% allocation to preference shares offers meaningful differentiation without excessively limiting equity-like returns. Consequently, this allocation tends to seldom experience significant shifts. However, if opportune, the managers are open to adjustments, as evidenced by their actions over the last 12 months, where they added in extra Standard Chartered and Lloyds preference shares at yields ranging from 6% to 7%.

The final dividend for the 2024 financial year of 4.8p brings the total payout to 14.4p, representing a yield of 6.0% at the time of writing. This represents a premium to both the AIC UK Equity Income sector’s weighted average yield of 4.2% and FTSE All-Share’s yield of 3.6%. The decision to reduce the percentage of management and finance costs allocated to income from 50% to 40%, as of the 2024 financial year, will help buttress the high-income potential of the shares.

Dividends were fully covered by revenue earnings of 14.75p, essentially flat on 2023’s 14.83p. While the income from the portfolio grew, the aSCI transaction increased the share count, and the timing of the transaction meant that many of the latter’s holdings had already paid their dividends. SHRS pays three equal dividends followed by a larger, final dividend.

On a rather dry, technical note, the board is proposing to cancel the Share Premium Account, which stems from the combination with aSCI, to make this account fully distributable by way of dividend or buyback. While there is no intention to pay dividends out of it, the board argues that the flexibility is in shareholders’ interests. There is already a substantial realised capital reserve which can be used to supplement revenue reserves (0.69 times the 2024 dividends). As such, we think investors can have high confidence in the sustainability of SHRS’s dividends.

Bear
Exposure to small- and medium-sized companies may bring more sensitivity to the UK economy
Funding preference share allocation through gearing may result in lower capital growth when markets rally
Out of favour home market and exposure to domestically sensitive stocks could weigh on the disco