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Seven Best of British shares

If Brexit fears prove overdone, there are grounds to hope shares in UK-focused companies could go on a tear
October 16, 2018

On the occasions this column runs a 'thematic' screen, it is usually a one-off. However, in an ode to the 'home bias' displayed by the majority of investors, the highly thematic Best of British screen gets a regular annual outing on these pages. The theme in question is a focus on companies with heavy exposure to the British economy. However, the come-rain-or-shine attitude I take towards this screen has meant navigating tricky markets over recent years as many investors have given UK-focused companies a wide berth and things may get trickier yet with the end game for negotiations on the UK’s EU exit deal now in firm focus. Indeed, key details could be known between the time of writing and publication of this article. Meanwhile, the uncertainty created by Brexit means many domestically focused stocks display noteworthy 'value' credentials.

While I made a very similar point a year ago prior to what proved a disappointing outing for this screen, there are grounds to hope that, if current Brexit wrangles do not end in some kind of disaster, simply having increased certainty about the UK’s future relationship with Europe could mean a bit of home bias pays off in the coming 12 months.  As no one can predict the future, and we are likely to know some key details soon, taking such a positive stance on domestically focused stocks is a gamble, but the low valuation of such shares suggests the odds being offered by the market are not bad.

So much for speculation on the unknowable. What can be said for this screen is that it has had a pretty poor run recently, with the top five picks from last year delivering a negative total return of 8.7 per cent while the broader version of the screen delivered a negative 8.6 per cent. This compared with a 3.0 per cent negative total return from the FTSE 350, which is the index this screen selects stocks from.

 

2017-18 performance

NameTIDMTotal return (17 Oct 2017 - 12 Oct 2018)
WhitbreadWTB19%-
BookerBOK10%-
CranswickCWK0.8%-
MarshallsMSLH-1.2%Top 5
WH SmithSMWH-7.6%Top 5
RedrowRDW-9.2%-
GreggsGREG-9.2%Top 5
PersimmonPSN-12%Top 5
Barratt DevelopmentsBDEV-13%Top 5
Taylor WimpeyTW.-14%-
BellwayBLWY-16%-
PolypipePLP-19%-
Crest NicholsonCRST-39%-
FTSE 350--3.0%-
Best of Brit--8.6%-
Top5--8.7%-

Source: Thomson Datastream

 

The poor run over the past 12 months means the Best of British screen has underperformed the wider index in four of the seven years I’ve run it (see table). However, in the years the screen has outperformed the market it has done so with noteworthy panache, which means it still boasts a cumulative total return that is superior to the FTSE 350 by some margin. Indeed, over the seven years the top five Best of British stocks have delivered a total return of 174 per cent and the broader screen has returned 120 per cent, which compares with 76 per cent from the FTSE 350. While the primary purpose of the screen run in this column is to highlight ideas for further research rather than present tradable portfolios, if I factor in an annual charge of 1.5 per cent to account for the notional cost of switching into a new portfolio at the time each new screen selection is published, the total return for the top five drops to 147 per cent and 98 per cent for the broader screen.

 

 

Year-by-year performance

Total return FTSE 350AverageTop 5
201113.1%16.4%21.7%
201216.8%35.5%42.2%
20135.2%1.9%2.4%
20142.3%45.9%55.0%
201511.1%-8.9%-0.4%
201615.2%12.6%9.8%
2017-3.0%-8.6%-8.7%

Source: Thomson Datastream

 

The Best of British screen itself is not overly exacting in the criteria it uses, except in so far as it requires at least three-quarters of a company’s revenues to come from the UK. The key focus is on quality and momentum, which are factors that may fare well against a favourable economic backdrop. The full criteria are:

■ At least three-quarters of revenue from the UK.

■ Three-month share price momentum better than the FTSE 350.

■ Return on equity of more than 10 per cent.

■ One-year beta of less than one.

■ Forecast EPS growth in this and the next financial year.

■ Better than average five-year compound annual growth rate (shorter periods used where a full five-year record is unavailable).

■ Net debt of less than 2.5 times cash profit.

The screen’s results tend to focus on certain sectors that are less adept at sourcing income from overseas. Housebuilders, retailers, construction materials and leisure companies are all mainstays of this screen. However, this seems fitting in so far as these sectors tend to have their fortunes tied to the health of the broader economy. It is of note that some stocks selected by this screen in years gone by no longer qualify as, faced with tough UK markets, they have sought to pursue growth overseas. Examples include JD Sports and Ted Baker.

A relatively small but decent enough number of shares passed all the screen’s tests. I’ve provided brief write-ups of the stocks below, albeit with four bunched together as 'housebuilders'. The accompanying table is ordered by three-month price momentum with the top five version of the screen consisting of the five stocks with the best momentum.

 

Seven Best-of-British shares

NameTIDMMarket capPriceUK RevFwd NTM PEDYFwd EPS grth FY+1Fwd EPS grth FY+23-month fwd EPS change12-month fwd EPS change3-month momentumNet cash/debt(-)
RedrowRDW£1,915m531p100%65.3%6.3%6.4%3.1%9.1%3.0%£63m
MarshallsMSLH£826m418p95%172.6%13.4%7.9%1.3%8.3%0.0%-£49m
Barratt DevelopmentsBDEV£4,942m488p100%79.0%4.2%6.1%1.1%1.1%-0.7%£791m
BellwayBWY£3,427m2,790p100%64.4%14.5%4.7%0.2%--2.9%-£131m
Primary Health PropertiesPHP£812m110p100%214.9%3.4%7.0%-1.0%-6.4%-4.5%-£659m
B&M European Value RetailBME£3,859m386p92%181.9%16.8%11.8%-0.1%1.4%-6.4%-£530m
Taylor WimpeyTW.£5,152m158p100%79.9%7.2%2.0%1.0%2.9%-7.6%£496m

Source: S&P CapitalIQ

 

Housebuilders

Four of the stocks in this year’s Best of British picks are housebuilders, including top stock Redrow (RDW). The heavy weighting towards a single, highly cyclical sub-sector is not altogether desirable, especially as there are signs that the cycle may be turning for housebuilders. Indeed, recent share price performance for the sector has been erratic and generally negative. Many consider returns on capital to be close to the cyclical peak and some downward pressures are emerging in the form of cost inflation, which has started to weigh on margins. Meanwhile, there are signs of cooling in some parts of the housing market and concerns about how prices will hold up once the government’s Help to Buy incentives are finally withdrawn. And while housebuilders may look relatively cheap compared with the rest of the market, these companies are expensive compared with their own histories, despite recently derating. A lengthier discussion of these issues was included with my recent 'high-quality large-caps' screen, which I found distressingly housebuilder-centric.

 

Marshalls

While there may be concerns about housebuilders, oversupply in the housing market is not one of them. Indeed, there is significant pressure on politicians to find a way to build more homes. Building supplies company Marshalls (MSLH) looks well positioned to benefit, with about 40 per cent of its business coming from housebuilding and plans to increase this percentage. Other key markets, such as rail and water, are also strong and the group’s first half went well despite unfavourable weather in four of the six months covered.

Performance is also benefiting from its £38m acquisition of CPM a year ago. This niche concrete specialist has taken Marshalls into 'below the ground' products (ie pipes and drainage), providing opportunities to cross-sell and to innovate. An increase in capital expenditure to take advantage of buoyant conditions as well as the CPM acquisition means the group has recently moved from a net cash position to having net debt of £49m. The balance sheet remains far from stretched, though, and management remains on the lookout for bolt-on deals.

 

Primary Health Properties

At a time when Brexit-related uncertainties are rife, the portfolio of Primary Health Properties (PHP) may offer investors some much-needed assurances. The company owns GP surgeries and about nine-tenths of its rent roll is government-backed. Leases on its properties are long and its properties are fully occupied. And although the company’s loan-to-value ratio of 44.6 per cent is high by wider sector standards, it looks comfortable based on Primary Health’s own history and the stability of the asset class it’s focused on. The shares offer an attractive yield, which unlike that of some peers is covered by earnings.

The ageing population and attempts to improve NHS efficiency by carrying out more routine procedures in GP surgeries support the long-term case for the shares. What’s more, the need for specially built surgeries, as opposed to the converted buildings many GPs currently operate from, plays to Primary Health’s investment case.

With relatively limited rental growth in recent years and relatively stable valuations, acquisitions are a key determinant of growth. Primary Health raised £115m in April through the sale of new shares at a premium to net asset value (NAV) to help with this. As well as looking to buy UK properties management sees opportunities to expand in Ireland (the data used by this screen seems to be taking a no-hard-border stance in amalgamating this into UK revenue), which is viewed as offering similar long-term attractions as the UK. To this end, early last month the company spent €37m acquiring a portfolio of three Irish GP surgeries, taking its Irish portfolio to eight properties with a valuation of over €100m.

 

B&M European Value Retail

Reading the headlines, it would be easy to conclude that all UK retailers should be given a wide berth, but Britain’s high streets and shopping centres do still have some bright spots. Discount retailer B&M European (BME) represents one – despite its name, only 7 per cent of sales are from Europe, and specifically Germany. The company offers the tantalising combination of high returns on capital (SharePad puts last year’s ROCE adjusted for lease commitments at about 12 per cent) and the potential to roll out new stores financed by internally generated cash. And while sterling’s weakness has recently caused some margin pressure, this is forecast to abate in the current year. There is an attractive yield to boot, especially once forecasts of special payments are factored in.

B&M puts its success down to the fact that it is focused on two of the three growth areas in retail: value and convenience. What’s more, the third area of growth, online shopping, has not proved a threat to the kind of shopping experience offered by its stores. The company also has a strong focus on its supply chain and hopes to boost efficiencies this year with the roll-out of a new warehouse management system. A 1m square foot Southern distribution centre is also under construction. 

B&M is opening new shops fast, with 45 pencilled in for the current year – at the year-end the store estate stood at 927. Expansion opportunities have been increased by the acquisition of Heron Foods last year, which is also allowing B&M to introduce more frozen and chilled foods across the estate. Meanwhile, the group’s German operation, Jawoll, has been through a period of restructuring and is expected to return to profit growth this year.

Despite the money being spent on expansion, broker Liberum forecasts that the group will be able to start paying special dividends of 10p a year while keeping net debt below two times cash profits (Ebitda). That would mean a 5 per cent dividend yield tacked on to what is a decent growth story. The tough conditions in the sector cannot be ignored, but B&M certainly shows more promise than many of its peers.