With further volatility expected in the stock markets and interest rates set to remain “lower for longer”, investors should consider buying these 3 defensive stocks for income.
Gaining market share
With growing concerns over slowing economic growth, non-cyclical income stocks such as Imperial Brands (LSE: IMB) are strongly back in favour. The tobacco giant has an exceptional track record of dividend growth, with dividends up 34% over the past three years alone.
What’s more, the fall in the value of the pound following the EU referendum gives it an immediate boost to the sterling value of its foreign earnings. Imperial Brands is especially well placed to benefit from this given that the company spent £4.6bn to acquire a portfolio of US brands only last year. The company is also gaining market share rapidly in the US, thanks to recent brand investment and new retailer agreements.
Looking forward, city analysts currently forecast underlying EPS will grow by 12% this year, with dividends set to increase by 9%. For the following year, earnings is set to climb a further 6%, with dividends forecast to rise by 10%. Imperial Brands’ share price is up by 9% since the EU referendum and this reflects confidence that the company’s outlook remains intact. Trading on a forward P/E of 14.9 (13.8 on 2017 forecast earnings), and with a prospective dividend yield of 4.4% (4.9% by 2017), the stock has room for further growth.
Strong competitive position
Although Pearson (LSE: PSON) is undergoing a difficult transition from print to digital, the stock remains an attractive income pick. With a yield of 5.7% and a forward P/E of 15.4, the stock is a tempting turnaround play too.
The company is facing a combination of structural and cyclical changes outside of its control, including curriculum changes in the UK and South Africa and fewer college admissions in the US. But investors are more concerned with competition in the education and publishing sectors, which could erode Pearson’s position in the marketplace. However, in an industry where trust in brands is paramount, Pearson maintains a strong competitive advantage.
Earnings is set to bounce back this year, with city analysts forecasting a 6% rise in underlying EPS this year.
Potentially lower borrowing costs
The increasing likelihood that the Bank of England will cut interest rates by the end of this year has certainly boosted the value of utility stocks. That’s not only because defensive dividend stocks become relatively more attractive investments when the yields of bonds fall, but also because lower interest rates would lead to lower borrowing costs, thereby boosting earnings.
Shares in United Utilities (LSE: UU) rose 8% following the EU referendum. As is typical of the sector, United Utilities has relatively high levels of debt — its net debt stood at £6.3bn as of 31 March 2016. With such levels of indebtedness, the company would benefit substantially from lower borrowing costs — a 50 basis point reduction in its average borrowing rate could boost earnings by around 4%.
Another reason to buy United Utilities is its inflation-linked dividend: the company has promised annual dividend growth of at least the rate of RPI inflation until 2020. This protection against inflation is particularly valuable for investors now, since short-term expectations of inflation have shot up following the fall in the value of sterling in recent days. With higher inflation expectations, faster dividend growth and a stronger share price performance should surely follow.
