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Starting from the bottom

Should value investing make its long-delayed comeback, this column speculated last week, there will be lots of opportunities to test whether it works.

Let’s assume, for the sake of argument, that the growing chorus is right and that value does find favour. Even after the recent vaccine-inspired stock market rally, there are decent reasons – take your pick from synchronised global growth in 2021, a weaker dollar, rising earnings, punished bond yields and extreme investor positioning – which might mean value finally catches a bid.

Then again, good reasons don’t determine the right time to buy, as post-GFC prophecies of value’s return have repeatedly shown. Ever since 2007, the cheaper half of US stocks has underperformed relative to the broader market. Even accounting for a strong run-in to 2020, this year has been record-shatteringly bad for value, all of which – somewhat paradoxically – only provides extra grist to the value bulls’ mill. “Value, if you won’t buy it now, when will you?” asks asset manager GMO.

Quite. Unless the Japanification of Western financial markets extends to stocks – in the Land of the Rising Sun, half of listed firms’ trading price remains trapped below book value, versus a quarter in the US – then it is reasonable to assume cheapness might once again become a virtue.

On London’s exchanges, there are naturally several bombed-out sectors in which to start a bargain hunt. But as an exercise in value discovery, we might as well begin at the very bottom. Exclude companies with negative shareholder equity (the price-to-book value metric wasn’t really built for figures below zero) and two FTSE 350 firms beat out the banks to trade at the sharpest discounts to their balance sheets in the index.

At 65p, shares in retirement benefits provider Just Group (JUST) have bounced 59 per cent since their Halloween low, but remain in deep value territory on a P/BV of less than 0.3. Strip out intangibles, as analysts like to do when valuing insurers, and that creeps up to a still-stingy 0.31.

Just’s potholed recent history helps explain such feeble sentiment. In 2018, profits were hit by a change in mortality and property price assumptions, before the group was caught badly short by tighter capital requirements for equity-release mortgages. The dividend was pulled, the chief executive left, and Just was forced to raise £300m in tier one debt and £75m in new shares at 80p.

To this we can add two prevalent fears around life insurers: the effects of ultra-low interest rates and bond market risks, both of which complicate the asset-liability management exercise. The chunky exposure to equity release mortgages has also stoked fears that falling house prices might clobber capital levels that, even after a recent £250m green bond issue, could be higher.

It’s possible near-term house price concerns remain overcooked. After rising 6.6 per cent in the last year, Rightmove thinks asking prices will tick up 4 per cent in 2021. Even if prices hold flat, the lifetime mortgages Just sells – which come with a promise to cover the difference if a forced house sale comes in below the value of the mortgage – shouldn’t lead to impairments or emergency capital plugs.

Compare that picture to Micro Focus International (MCRO), which trades at a similar discount to shareholder equity despite a seven-week doubling in its share price to 445p.

Once itself a canny exploiter of undervalued IT businesses, the group has been undone by changing customer buying habits. After the disastrous and expensive purchase of Hewlett Packard’s enterprise software business in 2017, leverage has rocketed and cash flows have contracted. After booking a $922m goodwill impairment charge with half-year results, investors have taken a dim view of the huge balance sheet value tied up in intangibles. And when intangible assets lose their aura, a sum-of-the-parts valuation becomes ever harder.

Another intangible is whether value stocks might land a premium from acquisitive competitors with long-term horizons. Micro Focus’ focus on cost-cutting could find it a synergy-minded bid, though net debt of $4.3bn would take some swallowing. What’s more, recent form suggests takeover appetite stems from growth prospects rather than an opportunity to asset strip.

While negative for the tech group’s recovering valuation, it might be a boon to Just, which is sitting on buoyant demand for guaranteed income products and defined-benefit pension schemes de-risking mandates. A recent share sale of privately-held annuity provider peer Rothesay Life was priced at net asset value.

Extending that value lens (or charity) to Just shares would put them above 200p.

Balance sheet items (£m/$m)JustMicro Focus
Total equity2,5565,005
Tier 1 notes294-
Non-controlling interest-1.51.4
Shareholder equity2,2635,003
Shareholder equity less intangibles2,118-6,182
Market capitalisation6541,479
Source: companies, FactSet, as of 16 Dec. Just balance sheet as of 30 June (£), Micro Focus balance sheet as of 30 April ($).