Schroders: Where We are Finding Value

We take a whistle-stop tour of the world and find out where Schroders' global value team is finding turnaround stocks other fund managers are shunning

David Brenchley 18 October, 2018 | 12:26PM
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Balfour Beatty engineer, value stocks, Schroder Recovery, stock and shares, Carillion, retailers

Schroders prides itself on its value stock picking skills - but its multi-manager team, led by Marcus Brookes, called the trend too early when it repositioned portfolios that way a few years ago. The MSCI World Growth index outpacing the MSCI World Value index 32.5% to 15.9% over a three-year period.

However, Brookes is sticking with his call, and took confidence from last week’s market correction that when the switch back to value comes, it will happen quickly. In the month to 17 October, MSCI World Value is down just 3.1%, compared to MSCI World Growth’s -5.5%.

And he has some talented value biased colleagues to consult this time around. Schroders two Recovery funds are top rated by Morningstar analysts.

The UK and Europe are the cheapest stock markets in the world at the moment, while US retail is also attractive, according to one of those Schroders colleagues, Simon Adler.

The Morningstar Silver Rated Schroder Recovery fund screens for the cheapest parts of the market before modelling the numbers over the past 10 – or more, if needed – years before weeding out any potential value traps.

Over the past 10 years, where growth stocks, up 249%, have beaten value stocks, up up 137%, comprehensively, Schroder Recovery has more than quadrupled investors’ cash.

But looking over shorter time periods the fund lags even the Value index, with Growth well ahead of both. Over three years, the picture is the same.

Still, says Morningstar analyst Peter Brunt, for investors that can tolerate the extra volatility that comes with the style and long-term outlook, “the managers’ resolute adherence to the strategy has seen them rewarded over the long term”.

Adler, who is co-manager on a number of global value mandates at Schroders, says the portfolios are currently filled with ideas from both the UK and Europe, but it does still have some exposure to the US.

“The UK market is one of the cheapest markets in the world. The CAPE - cyclically adjusted price earnings ratio - for the UK is 15.5 times today. That would imply, from 147 years of history, the UK will make you a 6-7% real return,” he explains.

“Europe is a shade over 16 times CAPE; the US is 30 times. So that means we’ve got a lot of UK a Europe in our portfolios.”

Below, Adler and another value-focused fund manger Bill Casey of the Schroder UK Alpha fund, run us through some of the cheapest and, consequently, most attractive parts of the global equity market.

Retailers

A sector that is well out of favour at the moment, retail has a number of headwinds to negotiate. However, Adler believes there are selective opportunities around. Despite his liking of the UK and Europe, it’s in this sector where he looks across the Atlantic.

“The US retail sector is much more attractive than the UK because lease lengths aren’t as long,” Adler says. “In the UK, when you sign up for a lease, you often sign up for 20 years. If you’ve got to pay your rent for 20 years, it’s basically debt. We don’t like that.”

The team’s screen threw up 30 retailers that looked really cheap, he says. After doing their analysis and ranking for risk versus reward, they rejected 28. The two they bought for various funds were Dillard’s (DDS), a department store based across the south of the US, and Buckle (BKE), a jeans retailer that operates throughout America.

After buying these, says Adler, Buckle doubled and Dillard’s surged 80% so the fund managed to cash in some profits earlier this year. “That was in a period where Amazon doubled. It was in a period where Sears was on its way to going bust.”

However, since the pair hit two-year and three-year highs respectively in June, they have both retraced around 28% “and are now starting to get back into attractive territory”.

But, like any value manager, the process is not infallible and can throw up some quite spectacular value traps, which happened to the team’s investment in Debenhams (DEB).

“We make a lot of mistakes – we try to strip out the value traps, but we don’t get rid of all of them,” concedes Adler.

To a point made earlier, Adler says Debenhams leases all of its stores after its former private equity owners sold the whole estate and rented them back. However, the team decided the risk was worth the reward. It still thinks there’s plenty of upside in the stock; “turns out we just got the risk score wrong. The risks are just far too big”.

Banks

As well as retail, banks are one of the three cheapest sectors around currently, says Adler. He owns a few in the UK, including Standard Chartered (STAN) and RBS (RBS). However, he also likes Italian names like Intesa (ISP) and UniCredit (UCG).

The latter two were added to the portfolios early in 2018, before political troubles in Italy really kicked off midway through the year. However, as worries over Italy’s new Government’s policies continued to trouble many, the team added to their holdings. “That’s the kind of opportunity we like. You have to take on risk, but we think the trade off’s very, very attractive.”

Adding to the point on UK banks, Casey says “they’ve got too much capital” at the moment because they are contingency planning for a hard Brexit.

“If there isn’t to be a crashing out of the EU situation, a company like RBS has got 205 of their market cap in excess capital and the CEO is desperate to give it back to us, or use it as a share buyback to take out the Government stake.”

Balfour Beatty (BBY)

Casey’s team is style agnostic, so can take value and/or growth bets. He says he’s currently looking towards value, too, but with a quality overlay.

Despite that, he does like Balfour Beatty, which is in infrastructure contracting – “not particularly a quality space, with companies going bust”.

However, Carillion’s collapse has completely changed the way the companies in the sector bid for contracting work now. There’s an extra emphasis placed on balance sheet strength, because these companies need to ensure they’re going to be around in 10 years’ time.

The previous focus on contract price just accelerated a race to the bottom and contracting margins, which eventually accounted for Carillion.

He explains: “I think the penny has dropped in the Government’s mind with this space in that long-term – 10, 20 year – contracts like high-speed rail or Crossrail you need a partner. You can’t be nickel and diming on price at all costs; it needs to be a responsible player that has a strong balance sheet and can execute well.”

Whereas Carillion worked on a zero-cash margin basis when bidding for work and then squeezing the supply chain, Balfour is “not trying to grow; they’re just trying to get margins up”.

“This is an earnings growth stock, not a top-line growth story. They’re not bidding for work unless it’s very much in their favour and the contracts are right.”

Meanwhile, with Carillion gone and others like Capita and Mitie under pressure, Balfour is now the employer of choice for engineers in a tight market, which is bound to be an advantage.

True, wages are growing at a faster pace now, but Casey is confident Balfour can pass on the increased staffing costs through signing inflation-linked contracts.

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
Rating
Balfour Beatty PLC367.80 GBX-0.16
Buckle Inc36.47 USD-0.79
Dillard's Inc Class A443.35 USD1.58
Intesa Sanpaolo3.54 EUR0.13Rating
NatWest Group PLC307.20 GBX-2.01Rating
Schroder Recovery Z Acc1.57 GBP-0.51Rating
Schroder UK Alpha Plus Z Acc1.05 GBP0.48Rating
Standard Chartered PLC775.40 GBX0.36Rating
UniCredit SpA36.15 EUR0.54Rating

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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