Windfall taxes

 

 

 
Ben Ritchie, Samantha Brownlee and Rebecca Maclean, Investment Managers, Dunedin Income Growth Investment Trust PLC
 
 

The recent political turmoil in the UK may have made for entertaining viewing, but its influence on domestic financial markets is likely to be limited. Sterling has moved a little and the 10-year gilt yield is marginally lower, but these effects are likely to be short-lived until the policies of the new Conservative Prime Minister Liz Truss are clear.

One of the main areas where politics and the corporate sector collide is over windfall taxes. In his time as Chancellor, Rishi Sunak took the decision to impose a one-off tax on energy firms, a reflection of the significant additional profits they have made while oil and gas prices have been high. There have been rumours of a similar tax on electricity providers, which could capture some of the renewable energy groups, but nothing tangible has so far been announced.

The impact on our holdings in Dunedin Income Growth Investment Trust has been limited. We don’t own any of the large UK oil companies because of our sustainability mandate, though our holding in TotalEnergies has some exposure.

It would be more of a risk if a windfall tax were imposed on power generation companies. We have a holding in SSE, which earns significant profits from renewable and conventional power. If it falls into the scope of taxation, it could hurt projected earnings. However, if anything, the recent political upheaval makes that less likely.

There is a philosophical question over windfall taxes: do they achieve the end objective of lowering the cost of energy to consumers at a time when prices are high? We suspect not. It won’t make the price of gas go down and may actually increase the cost of production. It may also deter investment in an area that we need to ensure energy security and facilitate the transition to low carbon energy sources. Windfall taxes will always be an attractive short-term expediency for politicians but in the longer term they are likely to do more harm than good.
 

Mounting shareholder pressure on climate change

 
In the latest AGM season, activists have continued to exert pressure on boards to extend their climate change ambitions. Many of the major banks and energy companies have been subject to protests, urging them to reduce greenhouse gas emissions or limit their financing of fossil fuel linked activities. In many cases, the protests are the tip of the iceberg and there has been a lot of work ahead of the AGM – tabling shareholder resolutions and designing more ambitious targets.

Boards, for their part, have often been in negotiations to try and shore up their investors’ support for their existing plans. This is increasingly effective. We see the number of shareholders voting for more aggressive resolutions dropping. That said, it is still a significant minority pushing for change and companies need to address this element of discontent within their investor base.

This tussle between activists and management teams is often a useful process. It helps us understand the situation in more depth and can help devise a strategy that is both ambitious and realistic to reduce emissions. It also highlights areas for improvement and allows us to develop our engagement strategy.
 

Earnings: defying gravity

 
Until recently, corporate earnings were the one area of strength amid a generally weakening economic picture. However, as price rises leave consumers and businesses with less disposable income, there may be limits to how long this can last. While it is relatively straightforward to pass on higher costs to customers in the short-term, this gets more difficult over time.

The companies in the Dunedin Income Growth portfolio continue to deliver resilient earnings, but are seeing pressure start to build. There have been good results from companies such as Pets at Home.

Even though it sits in the troubled UK retail space, the company has a good niche, which has allowed it to push through higher input costs. The group admits that the environment is challenging, but spending on pets is often considered necessary rather than discretionary. It also has other advantages – a good balance sheet, strong cash flow, a progressive dividend and a recently announced buyback.

We have also seen good results from Intermediate Capital group, one of the UK’s leading private equity and specialist financing groups. It brought forward its fund raising targets, put up its dividend and signalled that it would strengthen its balance sheet, preparing for any downturn, but still reasonably optimistic for the year ahead.

Are there any conclusions to be drawn from these examples? Companies are becoming more cautious and costs remain high, so it is likely to be a tough backdrop. However, there will be businesses that continue to thrive and we believe that those within our portfolio will show significantly more resilience than average. This will be a fraught and volatile year ahead, but good companies should emerge stronger.
 

Terms of engagement

 
We have strict environmental, social and governance criteria, which shapes the type of businesses in which we invest. However, all our investee companies can improve their performance. SSE, for example, is a leader on renewable energy, but we have worked closely with them to improve their Climate Action 100 score. We want to be supportive shareholders, helping companies to be as good as they can be.

Part of this is using our voting powers. We have voted against boards for a variety of reasons: excessive pay, a lack of diversity, the tenure of the audit firm. However, this is just one part of engagement and only happens once a year. In reality, we are involved with a company at a variety of stages.

At the moment one of our particular points of focus is on human capital management. In the aftermath of Covid, with significant disruption to labour markets and higher levels of inflation, employees are demanding higher wages. We want to ensure that companies are developing their employee proposition to mitigate these pressures and retain their best talent.

In building our engagement strategy, we draw expertise from across abrdn. That means if a company proposes a new remuneration policy with a greater focus on sustainability, we have experts in house that can analyse it. This collaborative approach helps to ensure our engagement is as effective as possible in bringing about real change.
 
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
 

 
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