Half full

It’s a knee-jerk reaction to think that investors will only suffer amid a market downturn. That’s not entirely untrue: plenty of stocks listed in London and other exchanges have suffered from a steady derating as the market contracts and portfolios are therefore bound to have lost some of their aggregate value. However, there’s always a way to find profit in this kind of environment, too. Quite often investors are told to ‘buy on weakness’ – specifically those perceived ‘quality’ plays that historically and traditionally trade at quite high multiples. Finding a compelling entry point can be quite tough in a bullish market and even on a long-term basis when we’re taught shares only tend to go in one direction. However, amid the recent downturn many of these companies’ share prices have weakened, and Buffett-minded investors could do well to seek value where there often isn’t any to be found.

In this feature we aim to highlight companies where we spy real opportunity to profit from a future re-rating in the share price – in other words, companies that in our opinion have been unduly punished by macroeconomic concern. But we remain mindful of stocks where this might appear to be the case, but actually, isn’t. Their problems are more deep-rooted, inherent and aren’t so linked to the macro picture.

Property prime for picking

Immediately to mind is St Modwen Properties (SMP). At the moment, the shares trade on a 30 per cent discount to book value given the group’s exposure to apartment values in London. But the truth is, its exposure – largely around the Nine Elms development in Battersea – even if valued at zero would leave the shares trading at a 20 per cent discount. So the shares still look pretty undervalued. Having said that, the herd instinct and rush for the door following a vote to leave the EU will undoubtedly cause the shares to fall, however unjustified. Unjustified because, ultimately, a housing shortage in London is a housing shortage – in or out. Another example is Workspace (WKP), which provides office space for small- and medium-size enterprises (SMEs) in London. The shares suffered a sharp de-rating at the start of the year. But why? Rental income is up and yield compression is bubbling along nicely. Is Brexit to blame again? The company is not believed to have one overseas tenant. Also, there is very little risk in the business model. It identifies a brownfield site, buys it, secures planning consent, and then invites a housebuilder to build houses on it for a nominal charge. In return, Workspace gets a custom built office accommodation block for no charge.

Sticking with the property market, buildings material supplier Michelmersh Brick's (MBH) shares are down more than a quarter since January so far. But the dividend payout was doubled in 2015. Operational gearing was exceptional, turnover grew 2 per cent, profit by two-thirds. Strong cash flow has enabled it to pay off all its debt, and there is a net cash pile left on the balance sheet. Demand for bricks is as strong as ever. So what’s the concern? Probably a collapse in the housing construction market following a positive Brexit vote. Once again, a chronic housing shortage makes this unlikely.

Healthcare: go small

Another sector under pressure is healthcare and biotechnology. True, biotechnology is volatile even in good times, but widespread concerns over pricing, the impending presidential election in the US and the prioritising of innovation over profit is driving several healthcare stocks lower and lower. Some, such as GlaxoSmithKline (GSK) have internal problems – management, a volume-driven business model and questionable cash-flow profile – while others such as AstraZeneca (AZN) have been focusing on driving research and development ahead of sales and profit growth. In fact, investing in traditional drug development in a market downturn isn’t always to be recommended – at least, not with seriously diverse portfolios that could offset significant losses.

Instead, the answer may lie in healthcare service providers that have a far better chance of performing in line with more permanent trends including an ageing population, demand for data sharing and a funding crisis across the NHS. One pick in this regard might include Constellation Healthcare Technologies (CHT), where the shares have fallen around 15 per cent since January. However, on a longer-term basis the stock is up around 12 per cent since we advised buying in over a year ago and the group continues to post some staggering figures. Profit is coming from a low base, but it leapt 350 per cent last year on sales that jumped by 41 per cent to $76.7m (£53.1m). Debt still only represents around 20 per cent of net asset value, which cash generation increased by 91 per cent between 2014 and 2015. Just one caveat: the group is highly acquisitive given the consolidation opportunities at this end of the market, so future fundraisings to fund deals pose a possible dilutive threat to retail investors. But that should reap rewards over the longer term.

A similar story comes from Constellation’s fellow Aim-traded constituent Mission Marketing (TMMG). On a rolling 12-month basis the shares are suffering a 13 per cent depression, but on our longer-standing two-year buy advice they remain 15 per cent to the good. Its agencies continue to attract mega-brand clients including airline British Airways, car manufacturer BMW and drugs giant Pfizer. Crucially, client retention remains high, with 59 per cent of the total operating income generated in 2015 coming from companies that have been with the group for more than five years and over 20 per cent from those that have stuck around for more than two decades. Eagle-eyed readers will spot that profit dipped last year – by around 5 per cent – but that’s largely down to the group’s recent growth spurt which has been fuelled in part by a string of acquisitions. Last year’s deal drove an 11 per cent improvement in operating income, but the associated costs inevitably weighed on the bottom line. Regardless, management saw fit to increase the dividend by 9 per cent. At the moment, the shares are on offer for a ‘cheap-as-chips’ six times forward earnings.

Retail has real bargains

On a more positive note, the retail sector has some real bargains on offer at the moment. Traditionally, stalwart stocks in this sector can trade at pretty chunky multiples, but there’s more on offer if you’re willing to bet against the market right now. Wholesaler Booker (BOK) is a prime example. The shares have been severely punished this year, not just because of the perceived softening in worldwide consumer markets, but because the group started to post a slowing in like-for-like growth at the start of the year. But the share price weakness is, to our minds, a serious buying opportunity. First and foremost, Booker is not a traditional grocery retailer. It does manage retail brands, including Premier and Family Shopper, but these are operated by independent retailers, which it supplies with goods. Booker’s role as a supplier means it passes through price deflation to its customers – independent retailers – while continuing to grow its own profits. Annual figures delivered sales growth, an 11 per cent increase in pre-exceptional operating profits and a 9 per cent improvement in statutory gains, suggesting Booker’s profit-and-loss account is as resilient as ever.

Most of this comes down to volumes and margins. Despite wider industry deflation of roughly 2.5 per cent, Booker pushed volumes up 2 per cent and a 16 basis point increase in margins to 3.11 per cent helped offset a 1.9 per cent decline in like-for-like sales. The group also ended the year with a healthy net cash balance and, following the recent integration of the Budgens and Londis acquisitions, will pay investors a special dividend worth 3.2p a share in return for their help funding the deal in the first place.

Another stock inherently linked to the macro picture is luxury retailer Burberry (BRBY). Luxury retailers in general have been suffering following concerns over Asian shoppers’ spending habits. Some, such as Jimmy Choo (CHOO) have an over-reliance on their Asian consumer base that can’t be denied, and the company’s move out of the FTSE 250 last week is testament to the challenge that business faces. We’ve been bearish on the stock since last October when we advised offloading the shares. Since then, the share price has fallen by more than a fifth. On the flip-side, we believe Burberry’s reputation as a quality investment should help see it through tough times. It’s going to be a long road. At the most recent set of results management laid out an extensive recovery plan which – rumour has it – might include recruiting another senior executive to ‘assist’ current chief executive and creative director Christopher Bailey, who’s just taken a massive pay cut.

Mr Bailey took on the joint role when former chief executive Angela Ahrendts left the business to join tech giant Apple (US:AAPL). That raises an interesting point: Apple’s shares (which are traded in New York) are down more than a quarter year on year, too. Back to Burberry. The stock staged a mini comeback in January, but has since lost momentum as the concern over Chinese growth intensifies. But better staffing is not the only part of Burberry’s new recovery plan.

The company also intends to claw back annual savings of £100m by 2019 through a new cost-cutting exercise, equivalent to roughly 10 per cent of operating expenses. It has also capped capital expenditure at £150m. Rather than focus on new openings, chief financial officer Carol Fairweather said any financial outlay would go towards store refurbishments and investment in digital operations.

Ms Fairweather also cited industry reports that claim most of the sector’s growth will still come from Chinese customers, either when they shop abroad or at home. In fact, so bullish is Burberry’s board that it has announced an annual rise in the dividend that takes the payout ratio to 53 per cent. It will also begin share buybacks in the 2017 financial year up to the value of £150m. Although the shares have weakened significantly, their forward PE ratio of 18 means the market still sees recovery potential here.

A final stock market stalwart poised for potential recovery could be Marks and Spencer (MKS). The vitriol launched at this company over the past couple of years has been intense, but not altogether unjustified. Sales and profits have been in a continual downward spiral despite a food business that continues to defy the wider deflationary environment. Most of the weakness lies in the general merchandise division which has lost sight of its core customer. But there’s hope on the horizon for those who aren’t faint of heart.

Steve Rowe, a lifer with M&S, took the top job earlier this year, replacing Marc Bolland. Mr Rowe had previously been credited with steering the food business from success to success, but only took over the day-to-day operations of general merchandise last July. Investors can’t expect an overnight change. M&S has a lot to do to rediscover who its customer is and reinvent its products for the modern woman.

The good news is the shares are going dirt cheap – around 10 times forward earnings which, for a company that still boasts national nostalgia, might be a low as it could go. However, a word of caution: this a good example of a company hit not just by poor sentiment. There are real, inherent problems at M&S which only the current management team can fix. Here’s hoping.

Under the radar

It might seem disingenuous to suggest that a business such as Equiniti (EQN) has fallen below the radar. After all, the group provides registrar services for about 60 per cent of the UK benchmark constituents, so chances are that most of us have had recourse to its services at some point.

But there’s a good deal more to the group’s corporate profile than registrar services. Equiniti provides an array of technical ‘backroom’ services in pension and loan administration, specialist business process and investment services. The business is thriving due to an increasingly complex regulatory backdrop and a rapidly evolving life and pensions market. Equiniti leverages its expertise in specific business areas, not only providing technical services that would prove prohibitively expensive for many companies to replicate, but also providing an effective consultancy. But outsourcing in these areas isn’t simply about saving money. When we spoke to Equiniti’s chief executive, Guy Wakeley, he stressed the importance of developing close client relationships, essentially embedding Equiniti within a given client’s operations, which not only provides opportunities to up-sell the group’s proprietary technology, but also leads to high levels of recurring revenues.

Shares in the group have risen in value by a fifth since the second quarter, but they’re only 16 per cent up on their flotation price from last October. We think the shares are being held in check due to anxieties linked to the group’s debt levels, but given the highly cash-generative nature of the business we think that any worries on that score are overblown. Trading on an undemanding 12 times forecast earnings, complete with a yield hovering around 3 per cent, the shares present a sound long-term growth play for your portfolio.

Like Equiniti, the business model of Charles Taylor (CTR) is predicated on its advanced expertise in specific areas of the financial services market, in this case serving the needs of clients in the global insurance industry. And, again, like Equiniti, the Charles Taylor business model lends itself to strong staying power with its client base.

The group has been plying its trade in one form or another since 1840, so its vast knowledge bank linked to underwriting, loss adjustment and the Lloyds market is perhaps unsurprising.

The group’s core operations have generated substantive revenue growth for decades, driven by Charles Taylor’s mutual insurance companies, while the adjusting business has expanded the top line every year for the last decade in spite of a largely moribund claims market. This area of the business is set to benefit from a step-up in activity in the global claims market through increased investments in personnel and new premises. Meanwhile, the insurance support services segment is also set fair as a result of the launch of a Lloyd’s turn-key managing agency, coupled with the investment in insurance software provider Fadata.

Shares in the group trade on a forward multiple of 12 and yield around 4 per cent on the income front. They’re broadly in line with both their 300-day moving average and their historic premium relative to peers. But given share price momentum and expanding avenues for growth, now is as good a time as any to add exposure to this unique service provider, whose share price rating fails to reflect its growth potential.

A word on oil and gas. A frontier oil and gas explorer/producer whose share price pulled back 28.7 per cent and 46.7 per cent respectively over the past two calendar years is Amerisur Resources (AMER). The shares have long been a favoured speculative option with the IC – and from what we’ve heard – with many of our readers. But now there’s real value on offer.

The driller’s operations are centred on Latin America, with the jewel in the crown in the form of the 14,341 hectare Platanillo field, located in the Putumayo Basin, in the south of Colombia. It contains something in the region of 23.7m barrels of light, sweet crude, with low levels of contaminants, thereby resulting in low refining costs and a high price premium.

Earlier this year, Amerisur received the final approval required to complete its interconnector pipeline with Ecuador, which will result in a substantial reduction in operating costs, while diversifying routes through to market. The pipeline represents a sea change for the company as it will enable Amerisur to target near-term exploration drilling at the Platanillo and Put-12 sites and open up partnership tariff agreements. According to analysts at Investec, Amerisur’s pipeline could become “strategically significant from a regional perspective”.

Naturally, the driller’s share price was hit hard by the prolonged slump in crude prices. But Amerisur’s management took a wise decision to pare back production until either the pipeline was operational or the oil price retraced. As our colleague Alex Newman put it on release of the group’s full-year figures in April “the balance sheet and reserves base were put ahead of thinner short-term cash flows”. The group is net cash positive, has strong production rates at its disposal, low production costs (and getting lower), together with highly prospective drilling campaign. Trading at less then half its estimated net present value, Amerisur is as good a play as any for anyone looking to benefit from the gradual recovery in energy markets. MR