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Six Best of British shares

The mood towards UK markets may be gloomy, but Best of British shares have delivered a thumping outperformance
October 13, 2020

There are plenty of things to lament about the UK market. British blue-chips are dominated by large, mature companies struggling to deal with industry disruption. Meanwhile, the backdrop of Brexit uncertainty and what has often seemed a bumbling response to Covid-19 appears to be weighing on sentiment.

But none of this means the UK market is bereft of opportunity. My Best of British screen not only attempts to hunt down promising shares listed in the UK, it also insists companies generate at least three-quarters of sales in the home market.

Despite the current angst about the UK’s economic prospects, the screen has done very well over the past 12 months. True, this was very much a game of two halves. The 17 shares highlighted by the screen collectively surged as phase one of Brexit was agreed and associated fears lifted. Then came Covid, accompanied by a build-up of fears relating to Brexit phase two. 

It’s against this backdrop of dour sentiment towards the UK that I’m re-running the screen for a ninth year. Given I originally devised this screen as a contrarian reaction to dire sentiment towards Britain, it’s possible the current conditions provide a good set-up. 

But as always with contrarian takes, there is nothing to stop things turning even worse than markets have already priced in. That said, as clever and worldly wise as it may sound to scoff, there could be a vaccine available for Covid next year. And as far as Brexit goes, while it may be that the dogma of public discourse has finally infected politics, on the basis of both sides’ self-interest, the most likely outcome of current negotiations would seem to be a deal based on intelligent compromises.

In terms of what will actually happen, my crystal ball unfortunately remains cloudy. What I can say with certainty is that based on Thomson Datastream’s numbers the 17 stocks picked by the screen last year delivered a total return of 1.1 per cent while the top five returned 7.7 per cent. That was a thumping outperformance compared with a negative 13 per cent from the FTSE 350.

12-month performance

NameTIDMTotal return (8 Oct 2019 - 6 Oct 2020)Screen
RightmoveRMV24%TOP 5
SafestoreSAFE24%-
SegroSGRO23%-
SoftcatSCT23%-
CranswickCWK19%TOP 5
Berkeley BKG17%-
Howden JoineryHWDN17%TOP 5
Countryside PropertiesCSP15%-
SSESSE8.7%-
Big Yellow BYG3.7%-
MarshallsMSLH3.1%TOP 5
Barratt DevelopmentsBDEV-10%-
Unite UTG-16%-
GCP Student LivingDIGS-24%TOP 5
GreggsGRG-27%-
Bovis Homes BVS-40%-
Crest NicholsonCRST-41%-
FTSE 350--13%-
Best of British-1.1%-
Best of British Top 5-7.7%-

Source: Thomson Datastream

 

This means over nine years the cumulative total return of the screen stands at 170 per cent, and 286 per cent for the top-five version. That compares with 64 per cent from the FTSE 350. While the screen results are viewed as a source of ideas for further research rather than off-the-shelf portfolios, if I factor in a 1.5 per cent annual charge to reflect real world dealing costs the total return drops to 135 per cent and 234 per cent for the top five. 

 

The screen itself is fairly straightforward. It looks for big companies generating over three-quarters of their sales in the UK that are also showing decent share price momentum and score well on a few measures of quality. 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 when a full five-year record is unavailable).

■ Net debt of less than 2.5 times cash profit.

This year, only one stock – Cranswick – passed all the tests.I have taken a closer look at it below. Five more stocks got through based on a weaker version of the screen, which requires positive results for both the Britishness test and momentum tests, but allows one of the other tests to be failed. The top five shares are considered to be Cranswick and the four others showing the strongest three-month momentum.

 

Six Best of British shares

NameTIDMIndustryMkt capPriceUK RevNet cash / debt (-)*Fwd PE (+12mths)Fwd DY (+12mths)DYEBIT marginROCEFwd EPS grth FY+1Fwd EPS grth FY+23-mth mom3-mth Fwd EPS change%
Marshalls plcMSLHConstruction Materials£1,373m687p95%£99m351.2%0.5%8.0%19.2%-66.1%125.6%7.9%-48.6%
Auto Trader Group PLCAUTOMiscellaneous Commercial Services£5,509m570p99%£282m311.1%0.5%69.3%60.4%-31.5%44.8%7.6%-0.1%
IntegraFin Holdings PLCIHPInvestment Managers£1,706m515p100%-£130m361.8%2.0%-50.6%9.6%8.1%7.4%6.0%
Polypipe Group PLCPLPBuilding Products£1,042m457p90%£85m241.7%0.7%10.5%12.7%-66.5%124.5%1.8%-46.8%
Softcat PlcSCTInformation Technology Services£2,291m1,153p100%-£42m291.5%1.6%8.5%-10.4%3.0%1.5%2.7%
Cranswick plcCWKFood: Meat/Fish/Dairy£1,886m3,590p93%£145m201.9%1.7%6.1%15.2%13.2%2.3%-1.8%5.4%

Source: FactSet

 

Cranswick

When a company is producing good returns on its investments, investors should applaud it for pumping more money into the business if it has the opportunity to deliver more of the same through growth. This is the proposition offered by meat processing company Cranswick (CWK), which has massively upped investment in its operations over the past five years (see chart below). 

Growth opportunities in poultry (13 per cent of sales last year) have been a particular target for investment. The company has also been spending heavily on acquisitions, which have recently moved the business into vegetarian products as well as expanding its farming interests.

However, big spending comes with the risk that anticipated returns will not materialise. Recent falls in Cranswick’s return on capital employed (ROCE) – the amount of operating profit generated in a year from every £1 invested in its operations – could cause alarm bells to ring on this front (see chart). But digging down into what’s going on, it seems more likely the full benefit from the spending will be enjoyed by shareholders soon.

One key indicator that returns are set to pick up comes from brokers’ earnings forecasts. Not only is strong growth predicted, but forecasts have been subject to noteworthy upgrades over the past year. 

 

The fall in ROCE also needs to be seen in the context of the type of spending Cranswick has undertaken. Because its investments are in big facilities that take time to build and get up and running, there is a bit of delayed gratification involved with spending. Added reassurance can be taken from the fact that much of Cranswick’s recent expansion of facilities is supported by pre-agreed contracts with customers. 

Meanwhile, when it comes to acquisitions, the money spent shows up as extra capital employed as soon as the deal is complete, whereas the full profit impact is only seen in the first full year of ownership. And in terms of drawing ROCE comparisons from the above table, the fact 2018 was a 53-week period means the high returns from that financial year are not representative.

All in all, it’s not too surprising that last year’s 13 per cent increase in operating profits (from FactSet figures used in my ROCE calculation) did not keep pace with a 28 per cent jump in average capital employed (money invested in operations).

Importantly, management has earned investors' trust based on their track record. Historically, the company’s success at generating growth and handsome returns on its investments is based on achieving relatively low margins on sales but high and reliable volumes. Indeed, while an operating margin of just over 6 per cent is hardly exciting, the fact that historically the company has been able to produce about £3 of turnover (closer to £2.50 last year) for every £1 invested in its operations is exciting.

The company’s customers are mainly large supermarkets, with 72 per cent of turnover coming from UK retail. The two biggest customers account for 23 per cent and 18 per cent of sales, respectively. This does mean there is a big risk attached to the loss of any one customer and also puts limits on pricing power. But Cranswick has built itself close relationships thanks to: its focus on product development; high animal welfare standards; supply chain transparency and security; and sustainability. Meanwhile, its investment in state-of-the-art facilities also protects its market position and profits. 

Contracts tend to be long and shield the group from movements in input prices. The recent acquisition of more farms, meanwhile, protects its supply chain and makes the company about 30 per cent self-sufficient. That said, involvement in farming also comes with operational risks.

The current financial year – the 2021 financial year – looks as though it could benefit from bumper trading. 

Lockdown has caused a big increase in demand from the supermarkets that Cranswick supplies. And unlike the supermarkets that have seen added costs, such as fulfilling more online orders, swamp the benefits from higher sales, Cranswick seems to have kept more of its gains on the table. That said, costs have gone up, including a £500 Covid bonus paid to all on-site staff – a gesture that suggests a management that appreciates what matters to its operations. The company also had to temporarily shut the smallest of its three slaughter houses due to a Covid outbreak.

While most of Cranswick’s sales come from the UK, it has also benefited from soaring demand for UK pork exports, where it represents about 60 per cent of the entire market. Chinese pig herds have been devastated by African Swine Flu more than doubling exports to the Far East. Exports as a whole have increased from 7 per cent to 11 per cent of sales over the last two years with high pig export prices making these sales very profitable.

Interim results are due out on 24 November and, given the backdrop, they could prove impressive. The benefit of recent spending on both acquisitions and facilities should show up in first-half numbers. The year will also benefit from new contracts with Tesco and M&S. All this sets the scene for further upgrades.

In the meantime, there seems to be something of a lull in investor enthusiasm, with the shares flatlining over the past three months. This could in part be an acknowledgement that the current trading tailwinds will inevitably ease at some point. Cranswick’s focus on premium products could also become an issue as consumers’ budgets tighten. 

However, given the recent share price softness, a good set of half-year results could prompt a decent fillip. And despite the growth prospects recent investment could spur, while the shares can’t be described as 'cheap', they are valued at about the five-year average based on both price to forecast next-12-month earnings and enterprise value to forecast sales. 

From a longer-term perspective, the group appears to have growth opportunities, especially in poultry, coupled with strong credentials as a quality operator.