Financial Mail - Investors Monthly
Pluck up your courage
It’s an exciting time for fearless bargain-hunters,
Fortune favours the bold. This old idiom could just apply to investors bold enough to venture into the UK or European equity markets.
Would-be investors must confront huge uncertainty created by Brexit, the British electorate’s shock vote to exit the European Union (EU). Prime minister David Cameron’s resignation afterwards added to the uncertainty.
“The UK was left rudderless,” says Philip Saunders, co-head of Investec Asset Management’s London-based multi-asset team.
Fortunately, the problem was resolved swiftly with Theresa May’s appointment as prime minister on July 13.
May’s task will be to push the EU’s Article 50 button, setting in motion the UK’s two-year-long exit of the EU. May stated after her appointment: “There must be no attempts to remain inside the EU, no attempts to rejoin it through the back door and no second referendum.”
Until Article 50 is invoked, the European Commission has made it clear negotiations on crucial issues such as trade will not begin. And the commission is expected to play hard ball.
There are certainly negative implications for UK economic growth. Weakening consumer demand, corporate reluctance to invest and hire staff and a sharp fall in foreign direct investment are looming. Hopes that UK GDP would grow by more than 2% in 2016 have been dashed. The country now faces recession.
Estimates of how serious it will be vary. The most negative outlook comes from the UK treasury, which predicts a 3.6% contraction of GDP over the next two years and 500,000 job losses.
Other EU members will also suffer, but to a lesser extent. The European Central Bank predicts EU annual GDP growth will fall from about 1.6% to 1.1%-1.3% over the next three years.
It adds up to what markets hate: uncertainty. “We face trauma in equity markets,” says Saunders. “But the storm will pass and markets will stabilise.”
For bold investors it signals the time to hunt for bargains. “There will be wonderful opportunities for long-term investors,” says Ricco Friedrich of Denker Capital.
A starting point and the least risky is companies with low dependency on the UK economy that will benefit from a weaker pound. “A collapse of sterling is a one-way bet,” says Dino Fuschillo, senior European equity fund manager at Sanlam Four.
The pound has already taken a hammering, at its worst falling 14% to a 31-year low of US$1.27/£ since the referendum result on June 24. The euro has weakened by 3% against the dollar.
“It is not beyond the realms of possibility that the pound will fall to parity against the dollar and stay there,” says Fuschillo.
A clear beneficiary of a weak pound is British American Tobacco (BAT), the world’s second-largest tobacco group. BAT bills itself as being the “most international” tobacco company in the world. With operations in 50 countries and product sales in 180 markets, the £13bn annual revenue group’s claim is well founded. In 2015 BAT derived 23% of its revenue in the Americas, 24% in Western Europe, 27% in the Middle East
A starting point and the least risky is companies with low dependency on the UK economy that will benefit from a weaker pound
British consumers are on the hunt for bargains. It’s a message discount retailer Steinhoff’s CE Markus Jooste has heard
and Africa and 26% in the Asia-Pacific region.
Another heavyweight in the “sin product” game is liquor giant Diageo. Of its £16bn revenue in 2015, 43% came from the Americas, 24% from Europe, Russia and Turkey, 20% from Asia-Pacific and 13% from Africa.
Highly profitable, Diageo boasts a 32% return on equity. While earnings have been flat over the past three years the group has continued to up dividends at a steady 8%/year. Current dividend yield is 2.8%.
Also standing out is Johnson Matthey, a FT100 group with diverse manufacturing activities including emission control technologies, speciality chemicals, pharmaceutical ingredients and medical device components.
In its year to March 2016 Johnson Matthey generated only 10% of its £10.7bn revenue in the UK, the balance coming from North America (34%), Europe (28%), Asia (19%) and other regions (9%). Over the past five years the group has grown EPS at an annual average of 13.1% and dividends at 8.2%.
In a similar space to Johnson Matthey is FT250 mid-cap speciality chemicals group Croda International, which in 2015 derived 60% of its £1.1bn revenue outside Europe and the UK. Over the past five years Croda has grown EPS at an annual average of 7.3% and dividends at 14.5%.
A company now very familiar to SA investors, Anheuser-Busch InBev (AB InBev) deserves a place on a potential buy list. The world’s largest brewer derived a mere 6.4% of its profit in Europe including the UK in 2015.
AB InBev has set a cracking growth pace over the past five years, lifting EPS by 14.7%/year and dividends by 29.6%/year.
With SABMiller about to come into AB InBev’s fold, the share is a firm favourite with analysts. Of 26 polled by Thomson Reuters, 20 expect it to outperform the market.
The likes of AB InBev, BAT and Diageo are defensive, sleep-easy shares and their prices post-Brexit have already moved up strongly. The really big winners could be lurking in sectors that have fallen heavily out of favour with the market.
Among the hardest hit has been UK commercial property, as investors run scared of the potential damage to office and retail property occupancy rates, rentals and values.
The biggest fear concerns office space in an oversupplied London. Many foreign banks may shift thousands of jobs from London to centres such as Frankfurt, Paris and Dublin.
The outcome of negotiations between the UK and EU on “passporting” will be crucial. This enables non-EU financial services firms to be based in London and offer services in the EU.
Amid investor panic, trade in more than half of the funds in the UK’s £25bn UK’s property fund sector has been suspended. In a scramble for liquidity, fire sales of property are a real risk.
All panic selling plays itself out. European insurer Allianz’s global strategist Neil Dwane puts a strong case forward for longer-term confidence in UK property. In a recent opinion piece, he noted: “There is an intense allure of UK and London assets to overseas investors who value legal certainty and exceptional property rights as much as they value returns.”
Selling of most UK listed property shares has left them trading below net asset value (NAV). Among them is Capital & Counties (Capco), now at a 14% discount to NAV. Capco, which at its worst post-Brexit level was down 26%, appears to be getting undue punishment.
Its biggest asset, at 54% of NAV, is London’s Covent Garden. By far the bulk of visitors who stream into this shopping precinct are foreign tourists — more than 40m annually. It would appear to make it immune to the UK’s woes. Indeed, a weak pound is likely to boost tourism.
Capco’s other two assets are also out of the line of fire of problems in the London office market. At 38% of NAV, the largest is Earls Court, now being redeveloped as a complex of 1,500 affordable homes.
Investors inclined to take a contrarian view should also consider UK house builders, a sector hit even harder than property. The largest, Taylor Wimpy, has seen its share price slide 27% post-Brexit.
May has made it clear house-building will be a policy priority. The Bank of England has also eased reserve requirements, a move increasing their lending capacity by up to £150bn.
It makes a share like Taylor Wimpy an interesting bet. Most analysts agree. Of 14 polled by Thomson Reuters, eight rate it a buy and five a hold.
There could be interesting bets lurking in the UK retail sector too. But they are unlikely to be among food retailers, which are still losing ground to German discounters Aldi and Lidl.
British consumers are on the hunt for bargains. It’s a message discount retailer Steinhoff’s CE Markus Jooste has heard loud and clear. Far from running scared of UK retail, which already accounts for 11% (£820m) of group retail revenue, Steinhoff is plunging in with ambitious plans to grow its furniture brands Harveys and Bensons for Beds. It is also tackling the clothing sector through Pep&Co, which has opened over 50 stores since launching July 2015.
Clearly confident in its proven ability to grow in hard-pressed consumer markets, Steinhoff has just acquired Europe’s biggest single price retailer, Poundland. The £597m cash deal brings with it 850 stores in the UK, 51 in Ireland and annual revenue of £1.33bn. Of 11 analysts polled, Steinhoff is rated a buy by eight, six of whom expect it to outperform the market.
However, the dust is far from settled on Brexit. That will take at least another two years. It makes for volatile markets, creating opportunities for bold investors who keep their nerve.