Some of the more defensive firms on the London stock market are showing weaker share prices over the last few weeks, such as Hikma Pharmaceuticals (LSE: HIK) and Britvic (LSE: BVIC).
In some ways, that’s not surprising as many have enjoyed a good run-up over an extended period stretching into years.
Why these two are defensive
Firms tend to earn the label ‘defensive’ if they have businesses with evergreen characteristics. Economic cycles, recessions and slowdowns tend to effect such businesses less than companies with more cyclical operations.
I think one of the main reasons a firm’s business exhibits defensive traits is because its goods and services often have a short life. Therefore, customers use up their purchase quickly and return to buy more, repeatedly. On top of that, defensive firms often deal in products deemed ‘essential’ by many users.
Hikma Pharmaceuticals’ business, providing generic and branded medicines to patients around the world, is a good example. People don’t tend to skip their medical treatments and medicines tend to be used up within a short time. Because of that, the company has built up an impressive record of cash flow, which supports profits.
Meanwhile, Britvic’s soft drinks business also supplies products with a short life. The power behind the firm’s success is found in its strong, well-known brands such as J2O, 7up, Robinsons and Tango. Customers’ brand loyalty seems to drive consistent cash inflows for Britvic and, just like Hikma Pharmaceuticals, the company has a decent record of cash flow supporting profits.
Uncertain times
To me, the crux of the case for investing in these two firms is in their ability to generate cash whatever the economic weather. If they keep generating cash then they can keep paying a dividend, and I think the niches they occupy in their sectors leaves them well placed to do that.
Defensive firms like Hikma Pharmaceuticals and Britvic can be popular with investors when interest rates are low and there is a lot of economic uncertainty in the air. The dividend yield available from many defensive firms can beat the rate of interest from many bank accounts. Investors have been buying the defensives, and price-to-earnings (P/E) ratings have risen with share prices as a result of all that buying.
However, recent events such as Britain’s vote to leave the European Union and the election of Donald Trump in the US seem to have led to a change in investors’ expectations for the macroeconomic environment, and some investors seem to be rotating out of defensive shares into more cyclical investment.
Decent long-term prospects
Hikma Pharmaceuticals and Britivic have seen their share prices ease off over recent weeks, but the directors of both firms seem optimistic about the longer-term prospects for their companies.
At a share price around 1,651p, Hikma Pharmaceuticals’ forward yield runs at just over 1.5% for 2017 and forward earnings are expected to cover the payment an impressive five times. With the shares at 547p, Britvic’s forward yield is around 4.4% with the payout covered almost twice by forward earnings.
I think right now looks like a good time to research these two defensive dividend growers with a view to buying some of their shares for the long haul.
