7 UK Stocks on the Top Picks List

Which UK stocks have made the European Core Pick List of attractively valued European-domiciled companies that possess sustainable competitive advantages

Morningstar Equity Analysts 10 January, 2017 | 9:10AM
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January’s edition of the Morningstar Europe Core Pick List features the most attractively valued European-domiciled companies that possess sustainable competitive advantages. This month’s list saw a moderate amount of turnover, as trading-level fluctuations and fair value estimate changes caused some firms to drop off the list and others under our coverage to be added.

Investors should note these are not stock tips, and you should only consider these stocks for your portfolio if you believe in their long-term fundamentals and want to add exposure to each stock's particular sector.

Firms that left the list this month included Givaudan (GIVN), Sky (SKY), Bayerische Motoren Werke (BMW), Banco Bilbao Vizcaya Argentaria (BBVA), Novartis (NOVN), GEA Group (G1A), and Centrica (CNA).

The FTSE 100 increased by 5.29% in December, while our overall European coverage trades at an average of 107% of our fair value estimates. Centrica left the list this month, as only one utilities firm made the list, owing to lower price/fair value ratios in other sectors. Givaudan, Sky, Bayerische Motoren Werke, Banco Bilbao Vizcaya Argentaria, Novartis, and GEA Group were positive stories, as share prices appreciated during the month.

New Additions to the Pick List

New additions to the list this month include Syngenta (SYNN), SFR Group (SFR), Johnson Controls International (JCI), Edenred (EDEN), Julius Baer Gruppe (BAER), Sanofi (SAN), and Rolls-Royce Holdings (RR.), as they represent some of the cheapest European names on an uncertainty adjusted price/fair value basis.

Sanofi, which was added this month, is a wide-moat healthcare company that develops and markets drugs with a concentration in oncology, cardiovascular disease, diabetes, and vaccines, including Lantus, an insulin injection pen.

Morningstar analyst Damien Conover notes that “Sanofi’s patent-protected drugs carry strong pricing power, which enables the firm to generates returns on invested capital in excess of its cost of capital.” Conover also points out that “we expect continued strength in the multiple sclerosis area, with potential blockbusters Aubagio and Lemtrada recently emerging from the late-stage pipeline. In addition, diabetes drug Lyxumia looks to be a strong complement to the company’s well-entrenched diabetes franchise.”

While the entire picks list became more expensive overall this month, the healthcare sector trades at the steepest average uncertainty-adjusted discount, followed by communication services. Meanwhile, only one energy firm and one utilities firm made the list this month.

UK Stocks on the List

Kingfisher (KGF)

There is a lot for medium-term investors to like about Kingfisher. A decade ago, the company was a multicategory retailer, an ineffective conglomerate of primarily no-moat businesses. Today, it is focused solely on home improvement, and we believe management is building upon some competitive advantages that are likely to provide stronger defences than most traditional retailers possess against the major secular challenges currently facing the industry.

Pearson (PSON)

Over the past two years, Pearson has experienced almost the perfect storm of negative events: declining university enrolments, the loss of testing contracts in the United States, a slowdown in emerging markets, and benign growth in K-12 educational spending. This caused the share price to fall by more than half between March 2015 and January 2016.Pearson now finds itself at a crucial juncture. Having shed predictable but declining publishing businesses such as the FT and The Economist, Pearson’s portfolio is now focused on the educational sector.

Imperial Brands (IMB)

Under CEO Alison Cooper, Imperial Brands is slowly transforming from an also-ran, albeit a highly profitable one, to a significant player and potential consolidator in the global tobacco industry. But despite recent value-creating acquisitions in the United States, we think there is more work to do, and of the three wide-moat European cigarette manufacturers we cover, we prefer the competitive positioning of Philip Morris International and British American Tobacco on the basis of their superior scale.

Petrofac (PFC)

Petrofac is a global engineering firm that designs, builds, and operates onshore and offshore oil and gas facilities. Most of its business is related to onshore projects, predominantly located in the Middle East, Africa, and the Caspian region. This segment typically contributes the bulk of revenue and net profits. Offshore work comprises the second largest source of revenue, but typically realizes smaller margins and profits due to the type of contracts offered, mostly variations of cost-plus versus the more lucrative lump-sum contracts for onshore work. What makes Petrofac unique is its integrated services offering, which comprises about 10% of revenue per year on average.

Rolls Royce (RR.)

Rolls-Royce is one of few firms in the world that can successfully develop and manufacture civil and defence jet engines, and this is a key reason we believe it possesses a narrow moat. The growing installed base of engines that have useful lives of more than 25 years results in a stable, long-term annuity of future services revenue. That said, we do see headwinds for Rolls-Royce, namely pressured widebody aircraft spending and weak marine offshore markets in 2016 and the company's absence in the next generation of commercial narrow-body aircraft.

Smiths Group (SMIN)

We think Smiths Group is well positioned as a leading player in niche markets. Its John Crane mechanical seal division provides a base of high-margin, recurring revenue while Smiths Detection offers good growth opportunities. We also see potential for improving returns in the next couple of years. Global security screening is likely to see robust growth with demand for detection devices extending beyond traditional locations, such as airports and borders, to more general public venues.

National Grid (NG.)

National Grid has grown into one of the largest utilities in the world since U.K. regulators unbundled energy distribution, transmission, and supply in the 1980s. National Grid began acquiring Northeastern US utilities in 2000 and made its biggest move buying New York-based Keyspan for $11.8 billion in August 2007.National Grid earns about 30% of its profits from the United States, but that will rise as the US dollar strengthens, U.S. regulation improves, and National Grid pursues large investment opportunities in the US.

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
Centrica PLC132.00 GBX1.42Rating
Eden Research PLC4.20 GBX1.20
GEA Group AG37.66 EUR-0.48Rating
Imperial Brands PLC1,999.50 GBX0.98Rating
Johnson Controls International PLC69.43 USD-1.69Rating
Julius Baer Gruppe AG50.60 CHF-1.56Rating
Kingfisher PLC248.60 GBX-2.81Rating
National Grid PLC882.00 GBX1.05Rating
Novartis AG Registered Shares95.01 CHF0.80Rating
Pearson PLC949.00 GBX-0.11
Petrofac Ltd14.45 GBX2.92
Rolls-Royce Holdings PLC457.80 GBX-2.14Rating
Sanofi SA86.43 EUR-1.71Rating
Smiths Group PLC1,681.00 GBX-1.58

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