Hermes: 3 Stocks Without 'Hidden Dangers'

Hermes Global Equity fund manager Lewis Grant warns investors not to pay for quality at any price as those stocks come with hidden dangers - and picks three equities that do not

Emma Wall 25 February, 2016 | 8:30AM
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Emma Wall: I am Emma Wall and I am joined today by Lewis Grant, manager of the Hermes Global Equity Fund to give his three stock picks.

Hi, Lewis.

Lewis Grant: Hi there.

Wall: So what's the first company today?

Grant: So the first company is American Water Works (AWK), which is a U.S. water utility company.

Wall: Sounds like it does what it says on the tin.

Grant: It does. I mean, you might be thinking it is quite a boring company and I am not actually going to try and dissuade you of that notion, and that's why I like it. I think in this market with so much volatility, so much uncertainty about which way the economy and which way the market is going to go companies like American Water Works offer a lot of earnings visibility.

The water industry in the U.S. is very highly regulated, which means we know what earnings the company is going to make. It is also an industry that is dominated by the municipals, most of the water is actually supplied publicly but they are beginning to sell-off those facilities and that allows companies like American Water Works to actually grow their earnings.

There is also huge infrastructure investment program, and again that's a regulated industry that earns just a steady return with great transparency. And so company like this is paying a 2.5% dividend yield that offers so much certainty of its cash flows really can do well regardless of what happens in the water economy. And that's why we like it.

Wall: I suppose usually utility is the sort of stock that offers little to no growth but a nice dividend. But you are saying because of the regulatory background, actually this offers growth as well?

Grant: That's right. I mean, it is not a high growth stock. I don't want to claim that. But certainly 5% to 6% revenue growth, that's actually quite attractive for utility and that is just because they are starting privatize so much of the water facilities; and a company like American Water Works can come in modernise the technology, make everything more efficient that works for everybody. So it is a win-win for both the public and the private companies.

Wall: And what's the second stock today?

Grant: So the second stock is O'Reilly Automotive (ORLY), which is a company we've spoken about before. It is an auto parts retailer and they service both the professional mechanics and garage as well as the DIY kind of home-enthusiast user. And that's why we like it so much because it is a company that's not particularly economically sensitive. You might think of retailer who is certainly sort of involved in autos is going to do very badly when the economy dips or if the economy dips.

Wall: Well, they do say that, don't they, they say the auto industry is a barometer for the economy in the U.S., in particular?

Grant: Absolutely. But O'Reilly is very different because they are servicing older cars that need maintenance. So actually when the economy dips and people can't afford a new cars, or can't afford to take the car to the garage they go to O'Reilly to fix it themselves where the oil price is so low, so fuel is so cheap in America, people drive more. So their cars need more maintenance. And again O'Reilly does very well then.

And so what we like about it is, it is a very high growth stock. I mean over the less seven years, they have achieved 20% earnings growth every year. For last 23 years, they have increased same-store earnings growth. I mean this really is a very consistent high growth name and yet, it's not particularly economically sensitive, that ticks all the boxes for us.

Wall: What's the third and final stock?

Grant: So the final stock is a little bit closer to home, it's a Spanish wind turbine maker, which is Gamesa (GAM). Now renewable energy is obviously...

Wall: A hot topic...

Grant: Absolutely, it is. Following the climate change conference in Paris, everyone is talking about it. But they have been talking about it for years really. It's just not been a very investible technology and that's because it's been so expensive. But certainly in the wind industry, with wind energy is now in some territories reaching good parity, which means it's actually comparable to producing energy from fossil fuels.

So suddenly it's a viable alternative without relying on government subsidies, and that makes it a great time to get involved and the company like Gamesa has got a focus on emerging markets. Gamesa was basically an emerging market play within wind energy. So country such as Brazil, Mexico, particularly India; India is going to be more than doubling its wind energy contribution over the next six years. That's a huge investment and Gamesa is the market leader there. So it's a great time to get involved in a technology that we absolutely need to embrace to ensure the climate change doesn't really affect us to the worse that it could.

Wall: I mean you mentioned briefly that sort of government support. I know that in particular the U.K. based renewable energy companies have been hit by the fact that subsidies have been significantly reduced, in particular solar, which I know is a different market but the same sort of fundamentals apply. You are saying that that actually we've reached a point when – you know even if there were no subsidies, this company could still do well?

Grant: Absolutely. I mean not in old territories. You are right that it does depend on the geography and on the current mix of fuels. But if you look at the likes of Mexico, India, there is opportunities here without government subsidies for companies like Gamesa to expand. So we are a tipping for wind energy now that it could actually become a significant part of our energy mix across the globe and it needs to. I mean the projection say that by 2050, we need to be getting 20% of our energy from wind power. Well, currently it's less than 3%. This is a huge growth industry, but now it's actually affordable as well.

Wall: Quite for shareholders and the globe.

Grant: Absolutely.

Wall: Lewis, thank you very much.

Grant: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The share class for new investors in the Hermes Global Equity Fund is the F class, which includes no trail and has an ongoing charge of 0.65%

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
American Water Works Co Inc139.08 USD2.10Rating
Federated Hermes Glb Eq F USD Acc  
O'Reilly Automotive Inc1,040.11 USD0.69Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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