JOHCM's Beagles: 4 Areas We're Finding Value in the UK

The UK is out of favour with many investors, but the very heavy de-rating seen recently has thrown up pockets of opportunity, according to JOHCM's Clive Beagles

David Brenchley 10 October, 2018 | 9:31AM

Brick construction

The Bank of America Merrill Lynch fund manager survey for September shows global investors are underweight UK equities. Investor sentiment surveys from both Hargreaves Lansdown and Lloyds Private Banking paint a similar picture, with Brexit uncertainties clouding the outlook.

But Clive Beagles, manager of the Morningstar Silver Rated JOHCM UK Equity Income fund sees the “very heavy de-rating” UK stocks have experienced compared to the rest of the market as an opportunity.

“Fascinatingly we’re at about the same level as we were back in the TMT boom in 1999. I guess that reflects a lack of technology in the UK index, as well as everything else,” he says.

This provides UK-focused money managers with a great value opportunity set.

“Even if equity markets do find it harder work to make absolute progress for the next five to 10 years, there are a set of stocks where we can make absolute, as well as relative, returns from,” added Beagles.

Below, Beagles outlines the four beaten-down areas he’s looking at right now.

Retailers

Retail is an area many are cautious of, with disruption from online in the form of Amazon, as well as the UK’s ASOS and Boohoo. Beagles admits it’s a controversial part of the market to be bullish on, “where structural challenges are very, very high and you need to tread very carefully”.

He is targetting good businesses that have seen their competitors falter, therefore presnting a chance to grab market share.

He owns Kingfisher (KGF), down 25% year-to-date, whose B&Q chain may benefit from rival Homebase’s travails under its new Australian owners; Halfords (HFD), down 10% year-to-date, where Evans Cycles and other independent chain stores are struggling; and DFS Furniture (DFS), whose rivals like Carpetright (CPR) look to be going out of business.

Domestically-focused Businesses

Overseas earners, which account for two-thirds of FTSE 100 firms’ revenues, have well outpaced their domestically oriented counterparts since the Brexit vote.

But Beagles notes that before the referendum in 2016, UK-focused firms were performing very strongly, saying: “So, no-one likes the UK and, within the UK no-one likes domestically oriented stocks. What does that mean? An opportunity, but you need to be a careful where you tread.”

As well as retailers, which fall into this category, there are a couple of other domestically-focused sectors Beagles likes. The first is construction, where his fund is invested across the whole supply chain.

This exposure includes brick makers Ibstock (IBST) and Forterra (FORT), construction groups Morgan Sindall (MGNS) and Low & Bonar (LWB), and bathroom and kitchen product manufacturer Norcros (NXR).

Also, he adds, “we’ve got some poorly run but improving names in the housebuilding area”. These include Bovis Homes (BVS), Countryside Properties (CSP) and Galliford Try (GFRD).

He also likes financials, particularly banks, with HSBC (HSBA), Lloyds (LLOY) and Barclays (BARC) all in the fund’s top 10 holdings. Insurer Aviva (AV.), asset manager Standard Life Aberdeen (SLA) and spreadbetting firm CMC Markets (CMCX) also feature in the portfolio.

“Financials continue to struggle to perform, with those stocks finding it hard to make progress. But we think there are things that are changing, whether it’s interest rates rising or excess capital beginning to be returned,” says Beagles.

Commodities

Beagles likes both mining and oil stocks. From a fundamentals point, the case for oil looks simple, with the oil price continuing to march higher. That said, worries over the future of the internal combustion engine compels some caution on the longer-term outlook.

The case for mining is less obvious, with US President Donald Trump’s trade war with China pushing mining commodity prices lower. “But we think the capex discipline’s far more important,” counters Beagles.

“People who run mining companies like to dig big holes and they increasingly like to dig bigger, deeper and more expensive holes,” he says. Historically, they have thrown cash at their businesses, trying to add more capacity, particularly during the Chinese boom period.

But that’s changed thanks to shareholders exerting pressure on miners. It’s helped that many are listed in London, meaning “there’s a self-reinforcing element here. Companies are almost egging each other on to be more strict”.

Meanwhile, new supply is shrinking and Beagles expects long-term demand to be robust. “Many commodities, whether that be copper, cobalt or nickel, are going to be winners from the electric vehicle evolution,” he says.

So, if supply does down and demand goes up, prices will rise. The firms’ de-leveraging means they have plenty of cash which, if they’re not investing it, should be returned to shareholders.

“The likes of Glencore (GLEN) and Anglo American (AAL) are on 13-14% free cash flow yields; they might give most of that back to us every year and yet this is a sector that most people just don’t seem to want to be invested in,” Beagles says.

Smaller Companies

Beagles says he’s been cautious of companies listed on AIM for a while. Now, though, he claims: “Quite frankly, small-cap valuations in the UK are just embarrassing.”

The manager picks out Lookers (LOOK), a car retailer, as a prime example. Clearly, he accepts, things don’t look great; UK car volumes fell sharply in the last financial year.

However, that wasn’t due to Brexit or the economy, it was due to the emissions scandal that rocked Volkswagen a few years ago. The fallout meant diesel cars became very difficult for people in the UK to own.

But that looks to be reversing now. Volumes have now begun to stabilise and new car sales have actually grown in the UK over the past two or three months, “so the environment has become less negative”.

More pertinent to Lookers, two-thirds of the company’s profits now come from used cars and aftersales services. Both of these areas of the market are higher margin and faster growing. “They’ve got a strong balance sheet and good quality backing,” he adds.

Despite this, the firm is trading on a price/earnings ratio of 7 times and yielding 4%. “That multiple is not untypical of stocks that we own in the small-cap sector. You kind of wonder what the point of being quoted is.”

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
Anglo American PLC1,964.40 GBP0.00
Aviva PLC419.90 GBP0.00
Barclays PLC158.74 GBP0.00
Bovis Homes Group PLC1,046.00 GBP0.00
Carpetright PLC24.00 GBP0.00
CMC Markets PLC77.70 GBP0.00
Countryside Properties PLC323.40 GBP0.00
DFS Furniture PLC253.00 GBP0.00
Forterra PLC287.50 GBP0.00
Galliford Try PLC548.50 GBP0.00
Glencore PLC276.70 GBP0.00
Halfords Group PLC240.20 GBP0.00
HSBC Holdings PLC654.70 GBP0.00
Ibstock PLC246.40 GBP0.00
JOHCM UK Equity Income A GBP Acc3.70 GBP0.14
Kingfisher PLC228.20 GBP0.00
Lloyds Banking Group PLC60.34 GBP0.00
Lookers PLC88.00 GBP0.00
Low & Bonar PLC14.50 GBP0.00
Morgan Sindall Group PLC1,306.00 GBP0.00
Norcros PLC195.00 GBP0.00
Standard Life Aberdeen PLC263.50 GBP0.00

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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