Food For Your High Yield Portfolio

By Stephen Bland (TMFPyad)
June 2, 2006

First Friday in the month marks usually, with today being no exception, the latest addition to HYP3, my high yield portfolio that I am constructing by monthly additions and in which I am permitting myself the luxury of being able to trade on occasion. Any trading though will likely be very rare as my general opinion is that HYP investors will be better off in the long term by not doing so. And the long term is what HYPs are all about.

Most readers will know that my HYPs 1 and 2 are never traded voluntarily and the performance of both so far has been outstanding. Whether I could have gilded the lily by trading a few of the shares, which almost certainly would have been the dividend slashers, is questionable. Big caps tend to recover from the depths of bad patches and over time this recovery can be quite spectacular both in the all-important dividends and the capital value which usually will follow. This recovery may often prove superior to the alternative share into which a switch might have been made. Incidentally this powerful potential for recovery is one major reason why I advocate that HYPs are invested primarily or exclusively in big caps.

Share 13 is Unilever (LSE: ULVR). Another very large cap, in the top quartile of the FTSE 100, and which takes the portfolio into a new area of diversification. The company is in the official sector of Food Producers.

For anyone who doesn't know exactly what it does, Unilever manufactures a large range of well known brands of food and household products such as Hellman's Mayonnaise and Surf washing powder, the former of which you stick on your chips, especially if you are from Belgium, and the latter of which you use to wash your clothes. Or is it the other way round? Anyway, whilst the exact nature of the business is not important in itself to HYPers, what is important is that an HYP is strongly sector diversified and Unilever is a further step in achieving that aim.

Here is the current standing of the portfolio so far.

For the year to 31/12/05 the company paid dividends of 45.1p. The forecast for 06 is 47.9p and 07 50.6p. On the 06 forecast then, the expected yield at my above buying price is about 4.0% rising to 4.2% for 07. Not huge but current yields in general are not that great once you've exhausted the few real biggies at the top of the FTSE 100. However it is decently above the current average for this index, which is 3.3%.

Cover is forecast at around 1.9 for 06 and 07 and that is somewhat on the high side of dividend cover in general, adding to the quality of the payout. Recent actual years and the forecasts show dividends increasing at around 6% annually, which is comfortably above inflation.

One downside is that the company is heavily indebted with gearing of 130% at the last annual accounts of 31/12/05. However this present excessive level of borrowing is well down on a few years ago when it was more like 300% so things appear to be moving in the right direction.

All debt is bad but whilst a small level of debt is nothing to worry about, substantial debt is potentially a problem because of the additional risks it imposes upon the business and, especially from an HYP point of view, the risk to the dividend. Interest must be paid before dividends.

However there is no way that an HYP can avoid shares with debt because almost all big caps carry some level of borrowing and for many of them this is quite substantial. So, much as I would love to produce a debt free HYP, or even one with only modest levels of debt, it is not possible. Doing so would inhibit seriously the range of available shares on good yields and also the diversification which is so essential to the success and low risk of the strategy.

> More info on the high yield portfolio strategy.

Of the shares shown Stephen owns Alliance & Leicester, BT, DSGI, Lloyds TSB and United Utilities.