Collinson: Securities Trust of Scotland peddles virtues of tobacco


It’s a long time since I have heard a fund manager peddling the virtues of smoking. They’ll tell you (somewhat shamefacedly) tobacco stocks are great dividend payers, but won’t deny they are about the most unethical thing to buy. Is that all about to change, as the giant players introduce “reduced-harm smoking”?

Securities Trust of Scotland fund manager Mark Whitehead names Philip Morris as one of his top stock picks, projecting that its sales will soar over the next year amid the “heat-not-burn” revolution. The maker of Marlboro has spent more than £1bn developing battery-powered devices called iQOS that have been an instant hit in Japan, where they were first launched. “It’s one of the biggest transformation stories in the marketplace” says Whitehead, who took the helm of the £185.1m trust a year ago. Philip Morris said last month that it had sold three million iQOS devices in Japan, a battery-powered “heat not burn” device that cuts out the vast majority of carcinogens inhaled when smoking.

Shares in Philip Morris have soared from $90 at the start of 2017 to touch nearly $115 by mid-April as investors bank on huge new profits from the devices. Whitehead is one of them. He reckons Philip Morris sales could jump by two-thirds between now and 2021 and that even at current elevated share price levels there is a good chance of another one-third rise in valuation from here.

“It’s really changing the way smoking markets will evolve. It could mean tobacco is no longer an ex-growth industry,” says Whitehead. The devices retail at around $90, so it’s not cheap, which means iQOS is only really a product for developed markets, and we still have to wait on how regulators will treat it, but it’s certainly a fascinating story. Already in Japan, it has grabbed an 8 per cent market share, according to Whitehead.

It’s also one of the few US stocks that Whitehead is upbeat about; although around 57 per cent of his portfolio is in North American stocks, he has been reducing as valuations have reached levels that now warrant serious concern.

“US equities have performed exceptionally well since Trump’s election. It has been led by the view that the US is dragging itself out of the deflationary hole, with Keynesian-style deficit financing of infrastructure to come. The question is can Trump deliver?”

Whitehead reckons it is finance and healthcare that will most benefit from Trump reforms. “The US spends 11 per cent of its GDP on regulations annually, compromising its productivity. There has been a phenomenal number of new laws added in the last eight years.”  One gets the impression that Whitehead wasn’t among those upset or dumbfounded by Trump’s victory, but he is worried about excessive exuberance since.

China is looking less attractive as well, he says, with few in the market properly taking into account the economic tightening now underway. The authorities in China effectively printed money by lowering the reserve ratio for the banks, but they are now reversing that, which Whitehead predicts will be bad news for the property market.

“So where do I see the opportunities? There are better economic growth figures coming out of Europe and European stocks to us look better value.”

He doesn’t count Britain in this reckoning. “We have only just started the clock ticking on Brexit,” he says, with consumer stocks, healthcare and technology all likely to come under pressure as higher inflation erodes spending power. He’s bearish on Brexit, worried that sterling could see substantial further falls, maybe towards $1.10 or lower.

“Inflation is now at 2.3 per cent and the market expects it to go to 3 per cent. If we get a crisis of confidence, it could head to 4 per cent or even 5 per cent. If that happens, we are going to get a very nasty recession.” The areas of the UK equity market better protected from inflation are real estate, energy and utilities, he says. But he adds that, in the short-term, the expectation of a Conservative win in the forthcoming general election should benefit sterling and be supportive of UK domestic stocks – to which Securities Trust of Scotland has good exposure.

The other big worry for funds that are reliant on UK stocks for dividend income is the dramatic level of concentration in the FTSE. Just 20 stocks produce 64 per cent of the market’s dividend payments. In Europe it’s more like 39 per cent, while for the MSCI World it is 18 per cent.

Securities Trust of Scotland’s aim is to produce a steady rising dividend, and currently yields 3.5 per cent, although it ate into capital last year to finance that dividend. This year Whitehead is confident that won’t have to be the case.

His approach is to “look for companies with a top-line structural sales advantage, which can fend off competition.” Inevitably it means the trust invests in pricier, high quality companies but he says history tells you they enjoy much better long-term dividend growth.

Airbus is his most favoured European stock. “Only 17 per cent of the world’s population has sat on a plane,” he says, predicting that Airbus will soar on the “mega trend” of the Asian middle-class. Asian airlines are snapping up Airbus’s fuel-efficient A320s and A350s, with the company now enjoying a nine-year order backlog. Whitehead sees it doubling its dividend over the next few years, with the scope for “even more returns via share buy-backs.”

Performance at STS has improved since Whitehead’s arrival, though it lags an admittedly mixed bag of investment trusts in its sector. Its share price is up 26.5 per cent over the past year and 31 per cent over three years, but that leaves it in third quartile over both periods. It currently trades at a 5 per cent discount. What STS probably best offers investors is a yield diversification, particularly if you share his downbeat assessment of Brexit, without having to stray into much higher risk areas. “A large divided is not worth much if it is not sustainable,” concludes Whitehead.

Mark Whitehead

Mark Whitehead joined Martin Currie in 2015 as head of equity income, and took charge of Securities Trust of Scotland the following year. He has 17 years of investment management experience, running the equity income team at Sarasin & Partners prior to joining Martin Currie. He currently leads a team of seven managers and analysts in Edinburgh, managing assets in excess of £850m. Data from Trustnet suggests that Whitehead has outperformed his peer group more often than not over the longer term.

The numbers

£185.1m Market value of the Securities Trust of Scotland

26.5% Returns over the past year place the fund in the third quartile

$115 Share price of Philip Morris, one of Whitehead’s top stock picks, at mid-April

$1.10 Whitehead reckons sterling could have further to fall