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2016 Tips of the Year half-year review

Our 2016 Tips of the Year have received a Brexit battering and are also missing out on the recovery in the resources sector
June 30, 2016

At the start of the year, many City analysts were talking about Brexit as a potential 'black swan' event. 'Black swans' are normally considered to be the type of event that former US Secretary of Defense Donald Rumsfeld famously labelled an "unknown unknown". The fact that the City painted Brexit in this light can partly be seen as a reflection of what a low probability the market attached to a Leave vote, given the associated economic risks.

IC TIP: Buy

However, the UK has voted to go its separate way from the EU and now the potential economic risks are feeling very real and markets are crashing. From this perspective, the 'black swan' can be seen as a reflection of the huge uncertainty about what the UK's departure from the EU would mean. Our 2016 Tips of the Year have been far from immune to the fallout.

With hindsight, it is easy to say our 2016 Tips of the Year should have been more alive to the possibility that the UK would vote to leave the EU and the repercussions this could have. But as it is, the tips find themselves showing a negative 0.7 per cent on a total return basis, compared with a 1.9 per cent gain from the FTSE All-Share (see chart).

 

 

Even before the Brexit vote did its work, our Tips of the Year were struggling to keep up with the market despite the fact that, for the most part, we felt the underlying arguments for buying were playing out well. A key reason for this uninspiring performance was that we consciously avoided resources stocks when compiling our tips, as I highlighted in my 2016 Tips of the Year write-up in January. Indeed, at the time it didn't feel as though we had seen a point of capitulation in the sector's bear market.

In the event, it now looks as though this point may well have come soon after our tips were published. The FTSE All-Share's five key resources sectors (oil & gas, oil & gas producers, oil equipment & services, industrial metals & mining, and mining) tumbled at the start of the year, but since 20 January have come back fighting and are now up 29.7 per cent since our Tips of the Year were published.

Given that these sectors account for more than a third of the FTSE All-Share, not being along for the ride has hurt our performance relative to the index. Indeed, non-resources FTSE All-Share sectors have registered a weighted negative total return of 8.9 per cent, a figure our tips actually beat quite handsomely. However, it would be wrong for us to take much solace from this fact as it is very much a case of what-goes-around-comes-around, given that our tips selections in previous years have owed some of their outperformance to the fact that we avoided resources stocks.

The table below shows the cumulative performance of our Tips of the Year over three and five years compared with the FTSE All-Share, excluding its five resources-focused sectors. It's pleasing to note that the longer-term outperformance of the tips continues to look good even if the first six months of 2016 have been disappointing.

 

Total returnFTSE All-ShareFTSE All-Share ex resourcesTips of the Year
2016 to date1.9%-8.9%-0.7%
3-year cumulative17%24%45%
5-year cumulative34%49%99%

Source: Thomson Datastream

 

The Brexit hit has left a majority of our 2016 Tips of the Year in the red, as can be seen in the performance table for the year to date.

 

2016 Tips of the Year so far

NameTIDMTotal return (7 Jan 2016 - 27 Jun 2016)
Penna Consulting*PNA31%
Walt Disney**US:DIS2.3%
RPCRPC-1.6%
J SainsburySBRY-2.7%
BAE SystemsBA.-3.8%
MJ GleesonGLE-4.3%
NewRiver RetailNRR-9.4%
LloydsLLOY-17%
2016 Tips of the Year--0.7%
FTSE All Share-1.9%

*Taken over **Sterling performance

Source: Thomson Datastream

 

The tips in detail

The stock that has received the biggest Brexit kicking is our Recovery Tip of the Year, Lloyds Banking (LBG). Prior to the referendum vote, Lloyds had been moving very much in the direction we had hoped it would. The group's 2015 dividend payment underpinned our case for buying the stock based on the expectation that it would use its much improved capital position to support a generous payout policy. Meanwhile, impairments are low and underlying costs continue to fall. What's more, the prospect of a deadline being set for PPI offers the prospect of stemming the tide of fines.

But Brexit, and the accompanying possibility that Lloyds' business will slow and financing will get harder, now represent a significant risk to prospects and can be expected to make the company think twice about using the balance sheet to support the dividend. Still, in share price terms, the real damage may well already be done to Lloyds and we think there are reasons to hope for upside from here as more becomes known about how the UK plans to disentangle itself from the EU.

Housebuilders and property companies were also horribly hit by the Brexit vote and we counted one of each among our Tips of the Year. Fortunately, if you were to own a housebuilder ahead of the vote, our Growth Tip of the Year, MJ Gleeson (GLE), is probably the one you would have wanted to have. Its focus on building genuinely affordable homes in the north of England has kept it insulated from the excesses associated with the London market, but it has still managed to produce consistent forecast-beating growth over recent years.

On the property front, our Income Tip of the Year was NewRiver Retail (NRR). Our argument in favour of this real-estate investment trust (Reit) was based on the fact that income from its property portfolio has recently grown to cover its generous dividend payout, and that it was planning a move from Aim to the main list that could see it included in the FTSE 250. The listing move is expected to happen in the next three months and we would hope this would lead to a pick-up in analyst coverage and investor interest. Set against that, the shares have fallen by just over 10 per cent following the Brexit news (that's actually not too bad compared with other real-estate investment trusts) and sentiment towards retail property has worsened somewhat. Nevertheless, NewRiver remains on the acquisition trail and continues to find canny ways to create value from property assets, such as its successful strategy of developing convenience stores in pub car parks.

The deflationary trading backdrop faced by our Contrarian Tip of the Year, supermarket group J Sainsbury (SBRY), could be made worse by Brexit, based on the fact that many economists and analysts think the move to exit the EU brings with it the risk of a recession. What's more, there are already signs that a price war in the supermarket sector will intensify as Asda starts to focus on protecting its position and discounters Aldi and Lidl continue their land grab. So far, Sainsbury has dealt with the changing market dynamics well and we'd expect this to continue. The biggest event for Sainsbury's this year was the surprise news, very soon after we went to press with our tip, that the company was bidding for Argos owner Home Retail. We've been won over by the logic of this deal.

Another one of our Tips of the Year (the Old Reliable) that has announced significant acquisition news is plastics group RPC (RPC), which is buying British Polythene Industries (BPI). Again, this deal sits well with us and RPC has a good record as an acquirer. Unfortunately, RPC has a lot of European exposure, so once again Brexit has hit the share price.

Our Takeover Tip of the Year, Penna Consulting, has also been at the end of a deal, but in its case, as we had hoped, it was prey rather than predator and the total return generated by the share was a 31 per cent gain. That was despite the fact that a very positive trading update from the group saw the shares surge between the time of going to press with the tip and publication.

Brexit has not been all bad for our tips. Our International Tip of the Year, Walt Disney (US:DIS), has benefited due to the dollar exposure it offers, while Value Tip BAE Systems (BA.) also does a lot of business across the pond and should benefit from the currency moves - a thin sliver of a silver lining.