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Oldfield: 3 Undervalued UK Stock Picks

Value investors Oldfield Partners says Rio Tino, Lloyds and Tesco are cheap and the outperformance of value stocks is here to stay

Karen Kwok 28 February, 2017 | 12:35AM
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Value stocks have seen a resurgence in recent months – after a prolonged period of underperformance. Over the last six months there has been a shift in fortunes, with value investing finally bettering growth stocks. But for value investor Oldfield Partners the style never went away.

One of the reasons for the outperformance of value investing over growth recently is the interest rise in the US, said Nigel Waller, chief investment officer of Oldfield.

“Value and growth both do well when interest rates start rising, according to history. And returns from value stocks tend to outperform growth stocks – so the trend seems to be replicating the history perfectly,” said Nigel Waller, chief investment officer of Oldfield.

“We have confidence that value will continue to outperform given that we are heading for a second interest rate increase in the US.”

Recently US Federal Reserve Chair Janet Yellen hinted that another interest rate rise was on the way thanks to the improved jobs market and rising inflation showing signs of nearing the central bank’s 2% goal.

Waller and his team love finding stocks that are disliked by the market as he believes investor sentiment changes frequently, which leads to the undervaluation of several stocks. He believes that value investors should look beyond investor sentiment and focus on fundamentals.

“We find stocks that the market is forecasting abnormally low returns for. Then we will ask why these stocks are so cheap, and why people gave them up – that’s where we find interesting opportunities. In absolute terms, lower valuations gives you higher returns,” said Waller.

Rio, Lloyds and Tesco are “Cheap”

Looking at specific stocks, the miner Rio Tinto (RIO) looks cheap despite the fact that its shares rallied 65% in 2016, according to Waller.

“Commodities are always in demand and Rio is the lowest cost producer in the world. We think Rio is a world leader in terms of cost and it has a good balance sheet. It is one of the best in the industry,” said Waller.

Mathew Hodge, senior equity analyst with Morningstar echoes Waller’s views, adding that Rio’s cash flow base is somewhat diversified, and is less susceptible to the vagaries of the market than single-commodity producers.

“The company's operations are also reliably run and are generally large-scale, low-operating cost assets,” said Hodge.

However, Morningstar analysts share a different view with Waller regarding the fair value of the stock because the near-term strength. Morningstar analysts gave Rio Tinto a two-star rating, meaning they believe the stock is trading higher than its share’s fair value estimate.

Waller also picked out Lloyds Banking group (LLOY) and supermarket stock Tesco (TSCO) as undervalued.

“We bought Lloyds shares at the end of 2016. Despite the potentially negative impact of Brexit, we think Lloyds remains a very dominant bank in the UK. It produces a high return on capital and it has one of the strongest balance sheets among European banks,” said Waller.

Stephen Ellis, director of financial services equity research with Morningstar agreed, saying Lloyds is now one of the best-capitalised banks in Europe and is set to begin returning capital to shareholders in the form of dividends.

“Since 2009, Lloyds has used all of its capital resources, both organically generated, and those raised in the markets, to write off its bad assets, pay massive regulatory fines, and deleverage its balance sheet, as required by regulators,” said Ellis. However, according to Morningstar analysts, shares in Lloyds are trading at their fair value estimate. Last week Lloyds posted net income of £2 billion for 2016, fourfold the previous year’s £466 million. 

Waller also believes that Tesco is cheap – stating that people often overlook the success Tesco has had in blunting the advance of the hard discounters where the like-for-like sales growth has collapsed. “People are overly worried about Tesco's domestic business. Recent sales figures have shown the company is in recovery but the rebuilding of operating profit margin is just taking a long period of time,” he said.

Morningstar stock analysts give Tesco a two-star rating, meaning they believe the stock is trading higher than its fair value estimate. Adam Kindreich, Morningstar equity analyst believes the market appears to be discounting too strong a recovery, and analysts are taking a more cautious stance.

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
Lloyds Banking Group PLC46.28 GBP0.00Rating
Rio Tinto PLC4,592.50 GBP0.00Rating
Tesco PLC280.65 GBP0.00Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk