5 Undervalued UK Stocks

Morningstar research suggests the UK stock market is fairly valued at the moment - but there are a few stocks that are trading at less than their fair value estimate

Emma Wall 11 November, 2013 | 11:41AM
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Investors looking to snap up some UK bargain stocks will be hard pressed according to Morningstar analysis. 

Morningstar's new Equity Quantitative Research recently revealed that as a whole the UK stock market is slightly undervalued, with the majority considered fairly valued following the market rally. 

Morningstar analysts research incorporates our view on a company's economic moat (sustainable competitive advantage over its peers), financial uncertainty and current share price versus the price our analysts consider the stock to be worth. 

While there are no 5-star LSE stocks under coverage at present--5 stars is the highest rating and means the stock is substantially undervalued--there are nine companies that have been awarded a 4-star rating.

We highlight five of them here and our analysts give their views on the outlook for these companies. 

BARCLAYS (BARC)

While Barclay's reported a big jump in statutory earnings for the nine months of 2013 compared to the year-ago period, the company’s underlying performance was obscured by a number of large one-off items, including a £1.4 billion provision for the mis-selling of payment protection insurance (PPI); a £650 million provision for interest rate hedging products redress taken in first-half 2013; and a £4 billion non-cash own debt charge taken in 2012, says Morningstar analyst Erin Davis.

While the high-level numbers look bad, we see some encouraging signs in the details - profitability remains good in UK Retail and Business Banking and at Barclaycard, and the fourth-quarter rights issue brought pro forma capital levels nearly up to mid-2014 targets. However, the poor performance of the investment bank and the acceleration of loan losses in Europe, as well as the bank’s disclosure that it is undergoing a probe into its foreign exchange trading, highlight that losses related to legacy issues are likely to weigh on returns for the no-moat bank for some time. We plan to maintain our fair value estimate.

BG GROUP (BG.)

As an oil and gas producer, BG's main risks include falling prices, says analyst Allen Good. Although oil prices are somewhat protected by OPEC, there is no similar influence in the regional gas markets on which BG relies more.

Weakening global economies and a glut of gas from domestic resources or other providers could destroy margins. Integrated oil companies are undertaking projects that will add to global natural gas supply, while cheap Russian gas could displace gas volumes in Europe and China. Also, if the link between natural gas and oil prices is broken, BG could see realizations and profits fall. BG also faces the geopolitical risk normally associated with operating in politically unstable countries, where damage to assets or renegotiation of contract terms may harm profitability.

While the lack of near-term production growth removes the primary catalyst for BG, we still see the long-term story intact and consider the shares undervalued.

ROYAL DUTCH SHELL (RDSB)

Shell today is facing a credibility problem in the market: our sense is that management has let the problems in its shale portfolio and downstream fester for so long that the market concerns have moved beyond these areas to include the company’s overall capital efficiency and execution, says analyst Stephen Simko.

There’s no question that management and the board have been painfully slow in addressing the company’s key weaknesses. Even though some actions are now being taken - shale acreage is being divested, shale rigs have been taken offline, a few refineries will be divested.

We still are concerned with how long it took for these decisions to be made. We can’t help but feel the best run large-cap oil companies would have recognized these operational weaknesses far earlier and acted much more rapidly to address them.

SSE GROUP (SSE)

SSE announced it will raise electric and gas consumer retail rates 8.2%, becoming the first of the big six UK power suppliers to announce price increases heading into the winter season, says analyst Andrew Bishof.

The move comes at a particularly sensitive time for utilities, as the Labour Party recently proposed freezing power and gas prices from 2015 and 2017.

Such a proposal could result in significant value impairment for UK utilities like SSE because it probably would result in lower investor returns. While we continue to believe the proposal is unlikely to become policy, today's announcement might increase political will to take action against SSE. Increasing retail rates continue to be a concern as government policy moves the country toward greater reliance on renewable generation.

UNILEVER (ULVR)

In our view, consumer spending will remain fragile, given that unemployment levels remain elevated and austerity measures are hampering growth prospects in Europe, says analyst Erin Lash. But we expect Unilever to benefit from new product launches as well as the breadth of its distribution platform, which spans the globe.

Although management has reiterated its sentiment that slowing emerging-market growth combined with intensifying competitive pressures will prove challenging for some time, we still think faster-growing developing regions will outpace sluggish prospects for more mature markets.

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.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Barclays PLC155.24 GBX1.65Rating
Royal Dutch Shell PLC B  
SSE PLC1,920.75 GBX0.43Rating
Unilever PLC3,531.50 GBX0.43Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar