Allianz: Buy UK Equities For Income

Despite Brexit concerns, the FTSE 100 yields almost 5% and Neil Dwane, global strategist at Allianz, thinks now's the perfect time to snap up some bargain stocks

David Brenchley 21 December, 2018 | 8:34AM

Ryanair plane, Ryanair share price, easyJet, FTSE 100, dividends, yield, UK stocks

Investors should ramp up their search for income in 2019, according to Neil Dwane at Allianz, as dividends will be a more important part of investors’ total returns next year. And Dwane calls the FTSE 100 a prime market in which to go hunting for high-yielding bargains.

After a decade of easy money made in rising equity markets, there are headwinds on the horizon. Interest rates continue to creep higher, volatility has picked up and earnings growth is predicted to slow dramatically. As a result, “the re-rating of equity markets is over”, claims Dwane, global strategist at Allianz.

Therefore, with share price gains set to be lower, Dwane expects the dividend return to become a larger part of an investor’s equity return for the next few years.

The hunt for income is nothing new. Ever since the financial crisis, ultra-low – or, in some cases, negative – interest rates have suppressed returns from fixed income vehicles and savings products.

So, investors have, for the most part, bid up income-paying stocks – many of which have become known as bond proxies due to their steady and hitherto sustainable dividends – to eye-watering valuations.

So, where should investors look for this income? We’ve seen many multi-asset fund managers turn to alternative sources, from infrastructure and property to more esoteric asset classes. But Dwane, who co-manages the Allianz Global Fundamental Strategy, is bullish on a much more mainstream area: large-cap UK equities.

The FTSE 100 yields just shy of 5%, with three – Taylor Wimpey (TW.), Evraz (EVR) and Persimmon (PSN) – offering a forecast double-digit yield for 2019, according to data from broker AJ Bell. “The UK is a great place to hunt,” says Dwane.

“You think about the 6.5% dividend yields of BP (BP.) and Shell (RDSB), the 5% dividend yield of Glaxo (GSK), Imperial [Brands] (IMB) yields over 8% - their clients are addicted; you’re going to get that income. You can pick 20 stocks in the FTSE 100, put them in your pension today and I know most of them will never let you down.”

True, the UK has been one of the worst-performing markets in 2018, shedding 12% of its value on a price return basis according to Morningstar Direct data. In fact, the FTSE 100 is currently 200 points lower than its closing price on 31 December 1999.

It’s also been one of the most hated asset classes in 2018, with investors pulling £8 billion from funds in the Morningstar UK Equity Income and UK Large-Cap Equity categories in the year to 30 November.

However, Dwane echoes the sentiment of Fidelity’s Bill McQuaker that those who wished to sell the UK have already done so. Dwane agrees: “The people who are nervous have got out of the UK.”

Sentiment towards UK assets is at an historically low level due to Brexit uncertainties. Dwane’s central case is the UK will agree a deal with the EU and vote it through eventually, but even if it doesn’t, he expects things to take a turn for the better come 29 March 2019. “Anything is better than where we are today when we literally have no idea what’s going on.”

Indeed, anecdotally speaking Dwane says international investors still see London as an attractive, go-to destination despite the Bank of England’s dire warnings of the impact of a no-deal Brexit. “If I ask Asian clients what they would do if sterling fell 10% and London house prices fell 10%, the answer is ‘I would just buy more’.

“It’s going to be interesting to watch the M&A next year because once we get clarity one way or another on Brexit you could see a lot of companies looking at quite cheap UK assets as well, which could support the market.”

That said, while Dwane recommends investors take the contrarian view and buy the UK, they still need to be selective. Amongst the high-yielding names, he says he’s “not quite as bullish on Vodafone (VOD)”, for example.

The world is becoming a trickier place, he continues, so the time to own low-quality names with high leverage has now passed. Instead, investors should look to higher-quality firms.

“If you think there’s anything inside your portfolio that’s super leveraged or you thought was a bit lower quality, I would question why you need to own that for the next 12-18 months. It’s not the time necessarily for taking those kinds of risk.

“And as we saw with ASOS (ASC), if you can’t justify the valuation, you are on very thin ice if something happens to that business model. We were surprised how bad the profit warning was, but it was on 67 times earnings, so you had to be super confident that business model was functioning because the valuation left you no margin.”

One contrarian stock he picks out that may contradict this argument is Thomas Cook (TCG), has had a 2018 to forget after unseasonably warm weather in the UK led holidaymakers to stay at home to enjoy the sun.

Two profit warnings this year alone ensued and the tour operator has seen its market value sink from £2.2 billion in May to just £440 million today.

Some have suggested the firm is over-levered, but Dwane sees potential value somewhere along the line. “It’s trading so far below book value that you now assume it’s going to go bust. But if you think Brexit works, this company is priced for death and if it lives you could make 10 times your money in the next two years.”

A pair of other firms that have endured a tough year for similar reasons are budget airlines easyJet (EZJ) and Ryanair (RYA), down 25% and 30% respectively. “Both of those companies’ share prices are now below the value of the aeroplanes on their balance sheets. I think that is interesting,” says Dwane.

A similar point can be made about some of the real estate companies, which are trading at discounts to their net asset value of up to 40%. “Although I would argue that I am less bullish on the retail side because my millennials will never go to Bluewater or wherever, 40% is a good place to start.

“Let’s say Brexit’s truly awful, the Bank of England are half right and everything falls 20% in the UK. Well, you’re still buying the real estate firms for significantly less than their properties are worth.”

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
Allianz Global Fdmtl Strat RT2 H GBP111.28 GBP0.21
ASOS PLC2,886.00 GBX-3.80
BP PLC549.30 GBX1.42
easyJet PLC892.60 GBX2.86
EVRAZ PLC650.80 GBX-3.70
GlaxoSmithKline PLC1,607.00 GBX0.12
Imperial Brands PLC1,869.20 GBX-1.26
Persimmon PLC1,936.50 GBX0.00
Royal Dutch Shell PLC B2,585.50 GBX1.15
Ryanair Holdings PLC9.86 EUR-0.88
Taylor Wimpey PLC156.45 GBX-0.19
Thomas Cook Group PLC14.45 GBX-1.60
Vodafone Group PLC128.34 GBX0.90

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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