Why Neil Woodford Has Sold Smith & Nephew Plc But Bought More Centrica Plc And SSE Plc

In the recently released February Fund round-up of Neil Woodford’s equity income fund, there were a few transactions that stood out to me as being rather contrarian.

Selling Out Of The Takeover Target

The fund has now disposed of its entire position in Smith & Nephew (LSE: SN).  Mr Woodford acknowledged that a bid for the company may well lead to a considerable appreciation in the share price.  However, with the share price at an all-time high, he felt that there were better opportunities elsewhere.  It is true that the company trades on a fairly lofty forward multiple of around 19 times earnings and expects to yield less than 2%.  It is also possible that the deal was sealed when Stryker, the US healthcare company, announced a $2 billion share buyback last week, finally quashing hopes that a bid was about to be announced.

Topping Up On The Unloved

In contrast, Mr Woodford seems to have seen an opportunity following the share price weakness of both Centrica (LSE: CNA) and SSE (LSE: SSE).

Centrica was the largest detractor to the funds performance in February, after the company cut its dividend with its full-year results.  Mr Woodford didn’t feel that the dividend cut was necessary but this may have simply be down to the new chief executive, Ian Conn, taking the opportunity to get any bad news out of the way early in his tenure rather than risk a credit downgrade.  It is fair to say that a dividend cut was already largely reflected in the share price. Centrica was hit by a combination of factors recently:

• US and UK weather conditions;
• The oil price collapse;
• Political and regulatory pressure.

However, he felt that these issues will abate and its long-term valuation attractions will become much more apparent.  He topped up on both Centrica and SSE, which was weak in sympathy.

Whilst we will have to wait until May for SSE’s full-year results and its final dividend, it did release a third-quarter trading update on 26th January.  It stated that:

• SSE still expects to report an increase in the full-year dividend for 2014/15 that will at least be equal to RPI inflation;
• Confirms that SSE is targeting an increase in the full-year dividend for 2015/16 of at least RPI inflation, with annual increases thereafter of at least RPI inflation also being targeted.

Where Does That Leave Us Investors?

With no dividend cut, SSE still yields over 6% but with RPI currently at just over 1% I wouldn’t expect outsized increases, either.  Whilst Centrica has bitten the bullet by re-basing its dividend, this will assist in reducing its debt and maintain capital expenditure — in the long run, it may be seen as a smart move… as may Neil Woodford’s top-ups.