Fidelity's Wright: Lloyds Bank is a Special Situation

Fidelity Special Situations fund manager Alex Wright favours undervalued turnaround stocks and says Lloyds Bank is on the up following a very difficult financial crisis

Emma Wall 25 April, 2016 | 12:01PM
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Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Alex Wright, Manager of the Fidelity Special Situations Fund, to give his three stock picks.

Hi, Alex.

Alex Wright: Hi.

Wall: So, what's the first stock you'd like to highlight today?

Wright: The first stock that I think really interesting today is Lloyds Bank (LLOY). It's been a long-standing position for me. It's about 5% of the fund, so within the top 5. It's still a very cheap share despite what is a big improvement in performance over the last couple of years.

So, earnings have really recovered here post the financial crisis, really strengthened the balance sheet and the company is now trading on only about 9 times forward earnings which compared to the market as a whole on about 15, so a big discount despite that recovery. Also, yielding on our analysis probably about 8% in special and ordinary dividends this year, so I think very attractive from a dividend point of view as well.

Wall: Obviously, your fund has the word Special Situations in the title. I know there's a number of different ways that you can choose to interpret that. Which sort of silo does Lloyds fall into within that idea?

Wright: Well, for me, special situations is all about stocks where significant change is happening and often that change is due to a recovery from a poor current circumstance. So, Lloyds clearly had a very difficult financial crisis after taking over HBOS which had an awful lot of problems and really needed to both rebuild its capital position and also improve its earnings after some significant losses. So, Lloyds is one of the more advanced stocks through that journey in the fund having got rid of a lot of those problems, really restructured the business and now in much better health today.

Wall: But still a little further to go?

Wright: Yeah, I think it's still undervalued given the journey that it's gone through. So, I would expect that the stock by now to actually be at a much higher valuation given they really have demonstrated that improvement in earnings and improvement in the balance sheet that you've seen over the last five years.

Wall: What's the second stock today?

Wright: So, the second one I want to talk about is CRH (CRH), another large company and another big position for the fund, something a bit more recent purchase and less of the way through its recovery journey, so still looking quite expensive today on near-term earnings about 15 times. But actually when you look at margins, they are half the level they were back in '07.

So, there is an awful lot of room for improvement over time and indeed our internal analysis at Fidelity suggests they can almost double margins over the next three years as they see an improvement both from their underlying markets in the U.S. and Europe as well as some large synergy benefits coming through from the recent transaction they have done buying a lot of assets from the combined Lafarge Holcim company.

Wall: And that's a construction company. How aided as that been by sort of government support? Does it build houses? So those homebuilders have obviously been propped up by certain initiatives from this government. Where does it fit into that?

Wright: So, this is much more for commercial and infrastructure investment. So, there is a bit of housebuilding, but that's pretty small and its key market is the U.S. and then its second market is pan-European and actually those markets are still quite depressed. So, while housing has been recovering and to a degree commercial construction in the U.S., that's yet to happen in Europe and then particularly infrastructure has only really started to turn around in the last 12 months or so and I think that's the next big kicker to the story in terms of its recovery.

Wall: What's the third and final stock?

Wright: So, the third stock I want to talk about is Bloomsbury (BMY). It's a much smaller business and a much more recent purchase and only for my smaller fund Special Values, one of about 20 stocks which are too small for Special Situations. I think this is interesting because it's a stock primarily known as the publisher of the Harry Potter novels. That's actually down to only about 5% of the business today and they've been quietly sort of using the cash flow from that and the rest of their publications business to build up an academic publishing business.

I think that's a much higher-quality business, much more recurring and steadier. But yet, the valuation of the stock hasn't yet moved, so only about 11 times earnings, yielding about 4% compared to peers who are more like 15 to 18 times. So, I think a good story in terms of a business model change there, moving to a more steady and higher-rated area.

Wall: I mean, it sounds remarkably like what Pearson is trying to do. But let's be honest, Pearson has not been a great story in terms of share price over the last 18 months. What makes you think that Bloomsbury can pull it off?

Wright: So, Pearson is primarily exposed to the U.S. textbook market whereas Bloomsbury is primarily a U.K. academic research. So, it's much more like a read business model where they've obviously done very well and you don't see sort of that pressure in terms of sort of the very high price of textbooks feeding into the business. So, I think that's why it's a better story. What's interesting though is Pearson is still rated about 15 times despite all those earnings pressures. So, that's why I think Bloomsbury is very interesting today.

Wall: Alex, thank you very much.

Wright: Thank you.

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

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
Bloomsbury Publishing PLC405.00 GBX1.38
CRH PLC3,289.00 GBX0.47Rating
Lloyds Banking Group PLC45.24 GBX-0.22Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar