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Rock-solid shares for your Isa

The IC companies team pick their favourite growth and income tips to give your Isa an equity boost
March 6, 2015

Historically, the majority of those using their annual Isa allowance have shunned investing in stocks and shares - of the 13.5m Isas opened in the 2013-2014 tax year, only 3m - just over a fifth - opted to hold equities within the tax wrapper, according to figures from Tisa. That's despite a typical fixed cash Isa interest rate at the start of the period being roughly 2.5 per cent, lower than the UK inflation rate at the time and well below the subsequent performance of the London Stock Exchange's major indices: the FTSE 100, for example, returned 7.5 per cent including dividends, and the FTSE 250 a massive 20.9 per cent in the 2013 tax year.

Why are savers prepared to sacrifice the returns on offer to investors? The familiar argument is that stocks and shares are "too risky", that markets are aking to gambling. Nonsense. It is certainly true that equities as an asset class are indeed more risky than cash - albeit that when savings rates are below inflation the purchasing power of that cash is being eroded with each passing day. But the flipside of that additional risk is higher returns, and risks can also be minimised by careful selection of the equities (or, as we've already highlighted earlier in this publication, equity funds) that you invest in. And by adopting some very simple investment best practices (not least the reinvestment of dividends in new shares), those returns can compound to very substantial figures over time and more than offset some of the inevitable 'down' years equities - both individually and in aggregate - will suffer. Here are 10 of our favourites.

 

Essentra

Speciality components supplier Essentra (ESNT:991p) continues to flourish under Colin Day’s leadership. Since he took over in 2011 when the group was known as Filtrona – a distinctly average cigarette filter manufacturer – its market cap has almost quadrupled and revenues and pre-tax profits have nearly doubled, thanks to a massive overhaul of the group’s culture.

Measures like growing the product range, aggressively cutting costs and acquiring businesses in markets underpinned by structural drivers have certainly paid off and suddenly make Mr Day’s recent pledge to achieve FTSE 100 status within the next five years seem quite feasible. Exposure to pharmaceutical packaging and heavy duty oil pipe protection regulation, together with growing healthcare markets and diehard Asian smokers, certainly improve its prospects of becoming one of the UK's biggest companies by 2020. Add the group’s fat – and growing – margins to the mix and Mr Day’s track record for getting the job done, and Essentra definitely has Isa-worthy credentials. DL

 

Hill & Smith

As mentioned in our 2015 tips of the year write up, we believe Hill & Smith’s (HILS) defensive growth prospects are worth investing in. Though hardly the most exciting of stocks, the global infrastructure and galvanising group’s status as the UK market leader for motorway upgrade kit leaves it well-placed to profit from the government's biggest road improvement programme for 40 years. Road safety, meanwhile, is a growing concern for a number of other regions that Hill & Smith serves, meaning this part of the business looks set to prosper for the foreseeable future.

But there are some juicy growth prospects in its other segments, too, like in galvanising, which generates about 57 per cent of group profits. Dipping components that make street lights, bridges and fencing in molten zinc to prevent them rusting is big business in the US, where construction and infrastructure investment is notably on the rise. Factor in these growth prospects with an unchallenging rating, decent yield, and a management team with an impressive track record and, at 575p, shares in Hill & Smith look very attractive. DL

 

Booker

Within the blighted, though now recovering, food retail sector lies a hidden gem: Booker (BOK:160p). Booker is a large cash-and-carry wholesaler, but it's also a major caterer to leisure outlets, restaurants, cafés and pubs. And, that corner shop down the road, branded Premier, that's a Booker brand too. So, while the group might not be the most exciting business on the stock market, it's all around us and it's a steady one, with a competent management team, set on solid, long-term sustainable growth. That much was clear from the first six months of this year, when Booker reported robust results: operating profit was up 15 per cent. And, following a special dividend payment of 3.5p a share in July, Booker plans to pay out a similar amount to shareholders in July next year. It has a history of generous shareholder returns and has a cash-rich balance sheet. As we've said before, this is a stock that remains enduringly attractive. JB

 

Dairy Crest

Dairy Crest (DCG) is set to be transformed. The sale of its struggling dairies business to Muller Wiseman for £80m in cash will turn the company into a leaner operation, with a well-invested asset base and stronger, more dependable cash flow. Granted, the deal still needs clearance from the competition authorities, but should it go ahead (which we think it will) Dairy Crest will be able to focus on its higher-margin cheese and spreads businesses. What’s more, it’s also investing £65m at its Davidstow creamery where it will produce high-quality demineralised whey powder and galacto-oligosaccharide – both bi-products of the cheese making process – for the fast-growing infant formula market. The project adds a further layer of value and diversification and is set to contribute to group profits by the 2016 financial year. What all of this adds up to is a stronger, fitter, more predictable business, and one we think some of the bigger global dairy and ingredients companies might even be interested in purchasing. In the meantime, at 491p, the shares offer a generous dividend yield and a low rating. JB

 

Tritax Big Box REIT

As Tesco’s recent decision to close 43 stores shows, landlords and real estate funds are not sheltered from the supermarket sector’s price war. Tritax Big Box REIT (BBOX) focuses on the distribution centres and industrial warehouses - so-called 'big boxes' - of online retailers, an altogether less risky link in the supply chain where tenants tend to spend more on site development than rent. Since listing in December 2013, the trust has snapped up 14 sites at a discount, quickly banking a 9.3 per cent portfolio value uplift.

That’s not to say the REIT is completely focused on supermarkets: Tritax has also struck long-term deals with L’Oréal and Rolls-Royce. At 113.5p, the shares still trade at a slight 6 per cent premium to net asset value, which is likely to re-rate given the trust’s strong track record in off-market dealmaking, and translate to a forward earnings yield just shy of 6 per cent, according to analysts at Jefferies. AN

 

Chesnara

Chesnara (CSN:350p) specialises in buying up packages of life insurance portfolios that are closed to new business. The idea is that these are run off over time, and as the size of the book diminishes, so capital requirements are reduced. This throws off a lot of surplus cash, and Chesnara has consistently rewarded shareholders with a bumper dividend of around 6 per cent. All of this is run with a tiny staff, its back room requirements having been outsourced.

In time, the insurance book would mature entirely, so Chesnara makes selective bolt-on acquisitions from time to time, and usually as a decent discount to the underlying value, depending on the quality of the book. A typical example was the purchase of the Direct Line Life Insurance business for £39.3m. This represented a hefty 25 per cent discount to the estimated embedded residual value of the life book. There is also a live part of the business called Movestic. This is based in Sweden, and after a few hitches - mainly soothing out relationships with local IFAs - the division is now profitable. JC

 

Imperial Tobacco

Tobacco stocks are controversial - what's good for a portfolio is not always good for the conscience. However, the sector has been attractive for investors seeking out medium-term income for some time now. In our view, Imperial Tobacco (IMT) has the competitive edge between London’s two listed cigarette giants. For a start, at 3,197p, the shares yield close to 5 per cent, but a seismic US merger will also play to the company’s advantage.

Compared to closest sector peer British American Tobacco (BATS), neither stock looks more expensive than the other. Both trade on approximately 15 times forward earnings. But Imperial will pay $7bn for the Winston, Salem, Kool and Maverick brands when Reynolds and Lorillard merge, and will pick up new e-cigarette brand Blu as part of the deal. Meanwhile BATS will have to inject $4.7bn into the newly-enlarged company just to maintain its existing 42 per cent stake in Reynolds. HR

 

AstraZeneca

AstraZeneca’s (AZN) status as a growth stock isn’t going to be an overnight story. Investors putting their money into the pharma giant will have to wait until 2017 to see any real return to growth. Furthermore, investors might be sceptical of the group’s ability to find its way again, especially since rebuffing Pfizer’s high-profile takeover bid last year.

But the truth is investors can earn nicely from AstraZeneca in the meantime. At 4,432p, the shares yield between 4 and 5 per cent. Admittedly, the stock trades on 17 times forward earnings – at a slight premium to close sector peer GlaxoSmithKline (GSK) – but this can be justified. First, AstraZeneca has a blue-chip status which income-seekers find appealing. Second, it isn’t planning a radical shift in its business model like GSK (following last year’s deal with Swiss group Novartis). Finally, its future oncology products look particularly promising – a field GSK has distanced itself from. HR

 

Rio Tinto

With iron ore trading at multi-year lows, it might appear counter intuitive to consider one of the three main global producers for inclusion in your Isa. The fall-away in prices has been linked to the massive capital programmes undertaken by Rio Tinto (RIO), along with its stablemate BHP Billiton (BLT), in Australia’s Pilbara region. This has resulted in a surge of lower-cost supplies on global markets at a time when China’s steelmakers have been reducing capacity.

However, this surge from the Pilbara is also forcing low-margin iron ore miners out of the market, which provides a long-term structural driver for Rio Tinto’s investment case. The miner, along with industry rivals, is now focused on freeing-up cash flows to drive investor returns, a point brought home by the group’s recent $2bn share buyback. Admittedly, the mining industry has been moving through turbulent times, but we think that Rio Tinto still represents a relatively low-risk play on emerging market growth – and we doubt if the current yield of 4.4 per cent will be on offer indefinitely as the shares recover more lost ground from the current 3,135p. MR

 

Micro Focus International

Technology companies and risk tend to go hand in hand, but that's not the case with Micro Focus (MCRO). The FTSE 250 listed software group, which modernises and maintains computer systems for the likes of Barclays, is a veritable cash cow that emphasises returns to shareholders: it paid out 60p a share in December, and has returned £533m to investors since March 2011.

True, the group's inflated debt following its recent $2.5bn (£1.6bn) purchase of US peer Attachmate may curtail short-term returns. But the combined group's exceptional cash generation should underpin healthy returns down the line. Micro Focus also offers strong revenue and profit growth. Analysts at Panmure Gordon expect cash profits to rise by three-quarters to $337m in the year to end-April, then by 47 per cent in 2016. Yet at 1,089p, Micro’s shares trade at an enticing 14 times full-year forecast EPS, and come with an impressive 7.4 per cent forecast yield this year, falling to 2.9 per cent in 2016. The shares are up 37 per cent on our buy tip (793p, 29 Aug 2013), but we think there's still value on offer. TM

 

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