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3 UK Stocks on the Global Value List

Morningstar equity analysts have released their list of the top undervalued stocks from across the globe - and 3 UK firms make the cut

Alex Morozov, CFA 6 November, 2017 | 3:26PM

WPP (WPP)

WPP, the world’s largest ad holding company, is on our Best Ideas list, as we think the stock’s recent decline has created an attractive entry point for this narrow-moat name. The shares are trading at a discount to our £16.40 fair value estimate. At current levels, WPP's dividend yields 3.5%. While we have been cautious regarding WPP and its peers, the selling is overdone, in our view. We think that what appears to be a slowdown in ad spending is driven mainly by geopolitical uncertainties that may have discounted the expectation of enduring moderate economic growth.

Further, we believe that during the possible slowdown, WPP can maintain its operating margin at its current 14%-15% level and reward its shareholders via dividends and share buybacks. The latest U.S. GDP and monthly economic figures provided some assurance that the economy will keep growing modestly despite the negative impact of hurricanes Harvey and Irma in the third quarter.

The European Union’s third-quarter economic numbers also have been reassuring. The annualized growth rate for the United Kingdom remained steady. While we view the latest indications as positive for the year, management has remained conservative and after releasing its third-quarter sales update lowered its 2017 organic growth guidance to flat from 0%-1%. We think WPP can maintain the 14%-15% operating margin range as it continues to streamline its agencies’ account management and increase efficiency in overall operations.

Our narrow moat rating is based on valuable intangible assets around WPP’s brand equity and the strong reputations of its various advertising agencies around the world. We also think the firm's continuing investments in consumer data accumulation and analysis give WPP a sustainable competitive advantage. Finally, to a lesser extent, we think WPP benefits from customer switching costs associated with further integration of its resources with its clients’ marketing departments.

Imperial Brands (IMB)

Imperial is the unloved stock in a sector that is very much in favor. The market is valuing tobacco stocks based on their exposure to heated tobacco, the emerging category that is achieving impressive growth in Japan and select markets around the world. We are bullish on heated tobacco, and we think a valuation premium for those leading and developing the category is appropriate.

However, we think the market is overestimating the value of the first-mover advantage, and if heated tobacco gains traction in other markets, particularly the U.S. and Europe, we expect Imperial to leverage its wide moat and follow Philip Morris, British American, and Japan Tobacco into the space with its own technology. Imperial's current multiple discount of 9 times P/E is much larger than the historical discount, and we think this is unjustified.

Royal Dutch Shell (RDSB)

Uncertainty around the safety of the dividend, integration of BG Group, and ability to achieve its 2020 free cash flow and return targets has weighed on Shell's share price. We think these concerns are overblown, however, and at current levels the shares present a compelling opportunity.

We see ample room for cost-cutting, upstream margin improvement, and reduced capital intensity that should ultimately improve free cash flow generation and secure the dividend. Meanwhile, the past few quarterly results have demonstrated Shell is well on its way to achieving 2020 targets.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Imperial Brands PLC3,085.00 GBX1.15
Royal Dutch Shell PLC B2,452.50 GBX0.95
WPP PLC1,389.00 GBX2.58
About Author

Alex Morozov, CFA  Alex Morozov is the director of the health-care team at Morningstar.