Schroder Oriental Income: The Long-Term Outlook

by The U.K. Income Investor

I am quite bullish on the long-term prospects of Asian stocks. Obviously, I’m talking about life after the COVID-19 downturn – the virus will hurt the region just like everywhere else. That said, the long-term outlook for the area strikes me as pretty attractive. Its equities trade at quite cheap valuations, while the longer-term growth outlook looks relatively good. That makes for an attractive combination in terms of investment returns. 

That brings us to the Schroder Oriental Income Fund Limited (SOI). As its name suggests, it is an investment trust focused on dividend stocks that operate in the Asia Pacific region. The company’s investment policy is to focus primarily on common stocks, though it does have scope to hold bonds and preferred stock.

As always, the best place to start is with the portfolio, which currently sits on around £640m worth of Asian blue chips. In strict geographic terms, this one is much less exposed to Mainland China relative to its reference index. Hong-Kong, Singapore, Taiwan and Australia take a correspondingly larger slice of the pie.

The portfolio contains around 75 stocks in total at last count. Among its top-ten holdings are BHP Billiton and Rio Tinto – well known to UK readers I’d have thought. Other large holdings include Samsung Electronics, Sands China (which owns a bunch of integrated casinos in Macao), Fortune REIT (owner of shopping malls in Hong-Kong), and the Hong-Kong subsidiary of the Bank of China (the second largest bank in Hong-Kong, after HSBC).

The Dividend

Let’s skip to what most people are interested in – the dividend. I’d imagine this one has been pretty popular with income hunters over the past decade or so. By my count, it has pumped out somewhere in the region of £6,250 in cumulative dividend cash for every £10,000 invested ten years ago.

Anyway, one of the reasons to like Schroder Oriental Income right now is its decent sized yield – creating what I like to think of as a ‘low expectation’ investment. What I mean by that is, if we can get a big chunk of total returns from well-covered dividends, then we don’t really need all that much growth on top. Indeed, a couple of points ahead of inflation should do the trick. The fund has managed to achieve that historically.

Here’s what we are looking at in terms of the numbers. Last year, the company reported circa £27.4m in net revenue. Obviously that came mostly in the form of dividend cash from the fund’s investments, minus its fees, taxes and so on. The company declared shareholder dividends worth around £26.4m in respect of the year, equivalent to 10.1 pence per share. (Bear in mind that exchange rate fluctuations can have a significant impact given the company reports in sterling).

Now, that per-share dividend figure has grown by 6.3% per annum going back over the past ten years or so. The corresponding net revenue per share figure has grown by 5.4% per year over the same period. If the company can continue to chalk up long-term growth in the mid-single digit per annum area, then we are looking at a double-digit compounder given the current 5.3% starting yield.

Outlook

That brings us nicely to its current outlook. As you might expect, the company’s share price has tanked this year because of COVID-19. The stock currently trades at circa 195 pence per share, and is down just under 25% so far this year. In fact, it currently trades at a 10% discount to its net asset value.

At the risk of stating the obvious, this year will be a tough one. The dividend income it receives from investments has held up relatively well so far, with that statement based on management’s calendar 1Q20 commentary. Of course, it remains quite likely that net revenue will not cover its current level of shareholder dividends. It’s the same story just about everywhere right now.

I’m more interested in the long-term outlook. On that note, I’d point to a couple of positive factors. First and foremost, valuation. As mentioned in the opening paragraph, it looks like Asia-Pacific stock market valuations are pretty attractive. Schroder Oriental Income’s portfolio trades at a price-to-earnings ratio of 13 according to Morningstar. Flipping that number on its head gives us an earnings yield of 7.7%. I think that looks very attractive in the current interest rate environment.

The second point, linked to the first, regards the region’s growth prospects. Sticking with Morningstar analysis, it points to long-term earnings growth in the 6.75% per annum area in terms of the fund’s portfolio. Given a 5.3% dividend yield as our starting point, that is just about fine once you chop off its fees. If you can look past the current volatility, I think this one will do quite well from here.

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