Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall, and here with me today to give his three stock picks is Philip Matthews, manager of the Schroder UK Alpha Plus fund. Hello Philip.
Philip Matthews: Hi.
Wall: So what's your first stock?
Matthews: I think the first stock would be Glaxo (GSK). As I said earlier, I think some of the the lower growth parts of the markets, the high-yielding parts of the market are looking relatively attractive compared to some of the cyclical parts which have done well over the last 18 months.
Glaxo is a name that I've been building a position in over the last six months. When I look at kind of long-term valuation multiples, the pharma sector is one which is showing up as relatively cheap and Glaxo is going through a period of transition. It's transitioning its respiratory franchise away from ADVAIR to new drugs. It has got a tail of products which I expect will be divested gradually over time. I know it's going to focus on the three areas of respiratory, vaccines, and then its consumer health division. It's yielding about 5% at the moment and I think that looks relatively attractive.
Wall: I mean, that definitely is attractive, given especially how low, both inflation and cash rates are at the moment. The thing of concern with many people with pharmas is the patent cliff. You've mentioned there that they have some things coming through the pipeline. So I suppose the flip side of that is, is that sustainable, and if so how expensive is that, how much CapEx do you have to do, to keep those drugs coming through?
Matthews: Yeah, I mean, Glaxo has really kind of got to the end of its patent cliff. So, ADVAIR was the big drug which they needed to fund follow-on drugs to come through. They've got two; BREO and ANORO which are launching in the States at the moment. The risk really is the extent to which those new drugs takeoff and where pricing pressure comes in on ADVAIR and whether a generic in the U.S. comes in over the next few years; but in terms of getting that kind of regulatory approval, that has come through now. So that's a big positive.
Wall: And presumably the risk that you've just talked about is priced in?
Matthews: I believe so at this level, yeah.
Wall: And what's the second stock then?
Matthews: So the second stock would be Taylor Wimpey (TW.). I said at the beginning, there has been this kind of big rotation out of some of the cyclicals recently this year. I think, to a large extent, that has been kind of froth being blown off the top of some of the cyclical names; but when I look at the house builders, the level of underperformance there, up until about a month ago was pretty dramatic.
Wall: The concern with the house builders is that they are much more exposed to political risk than perhaps other stocks. You've mentioned there that the interest rate's going up at the end of this year, well Mark Carney keeps changing his mind, sometimes it's 2017, sometimes it's 20 – you know. Also there has been talk in Parliament about doing something to control the housing bubble and indeed, there have been warnings from Bank of England members. So, how much do you have to bear that in mind when investing in that stock?
Matthews: You definitely do, because you know the housing market from a demand standpoint is being helped by the Help to Buy scheme. So, a lot of the transactions that are taking place helping first-time buyers get on the ladder are dependent on governmental support. So, there is a risk there.
Secondly, you know there is a risk around timing of interest rate rises and the extent to which that might impact affordability. At the moment affordability looks relatively okay on a kind of percentage of income basis, but house prices do look expensive when you look at them as a multiple of income.
So, when you look at how much people are having to pay to service their mortgages, if there is a big step-up in interest rates, then that could cause some problems. So, I don't think that's likely to happen, but this is clearly a risk.
Wall: And what's the third stock?
Matthews: So, third stock would be Sage (SGE) which is the accountancy software company. I think the current market – within the current market, when I'm trying to kind of find the best combination of value and quality, I'm looking for those companies where there is a very strong kind of recurring nature to the profit stream. Where those companies are generating a lot of cash, don't require huge amounts of capital to grow and where there is potentially some cyclical upside. A company like Sage, I think, kind of encapsulates that quite well.
Wall: Philip, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.
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