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Asset Diversity: Beyond the UK 100

Diversification is key; we present our MidCap portfolio

 

To provide some context – we have short term concerns relating to the UK 100:-

 

i) The  100 high weighting towards petroleum (14.45%) / miners (7.67%) and the impact of steadily declining commodities prices on these sectors. The numerous “failed rallies” in UKcommodities so far in 2015 suggests to us a persistently weak commodities market.

ii) A very weak Euro, the natural result of €60bn in monthly bond purchases, that will impact companies with large EU businesses ie. Vodafone, Diageo, RD Shell.

iii) The forthcoming UK General Election may impact blue chip stocks disproportionally, due to the 4.1% weighting of UK regulated utility companies in the UK 100.

 

It strikes us therefore the current environment contains a number of special short term factors that will impact the UK 100. Hence we have gone for our top picks in the UK 250 that are less impacted by these issues.

 

I have selected a portfolio of eight companies from diverse sectors in UK 250 and run a data series using information from the period 1 March 2010 to 1 March 2015 that provides return, risk and Sharpe ratio (the Sharpe ratio is the return per unit of risk adjusted for the risk free interest rate). Generally, the higher the Sharpe ratio, the better risk adjusted returns.

 

The intention is to provide technical data that supports an investment case that is based on the relevant companies’ ability to generate shareholder returns.

 Company Returnμ RiskΣ Sharpe Ratio μ/σ
Alliance Trust 0.77% 6.94% 0.11
Britvic 1.87% 6.64% 0.28
Capital & Counties 2.11% 5.35% 0.40
Debenhams 0.89% 9.18% 0.10
Greene King 1.69% 4.58% 0.37
Investec 0.81% 7.13% 0.11
Inmarsat 1.27% 6.72% 0.19
Rexam 0.68% 6.55% 0.10
1 March 2010- 1 March 2015The table looks at monthly return and standard deviation data over a 5 year period.

Source; CSS Investments Ltd

The selection above identifies high risk stocks (high σ) that are not providing compensating returns (μ) ie (Debenhams and Rexam). In both cases we are confident the return will improve over 2015 due to special factors affecting both companies.

Portfolio Particulars – individual equities details

 

Alliance Trust (ATST) BUY

Alliance Trust is UK 250 quoted UK investment trust specialising in diverse listed equities (97.7%) alongside some private equity assets (4.3%) and some fixed income (6.6%). The managers do employ some gearing- borrowing is c. 13.2% of portfolio assets.

Company Alliance Trust
Share Price 505
Target Price 550
52 Wk Hi/Low 499/426
Shares O/S 522.78m
Market Capitalisation £2.8bn
Avg Daily Volume 492k
Dividend Yield 2.04%
Key CatalystsFinal results; net asset value total return of 8.1% or 546.8p per share underperformed the return in its benchmark MSCI All Country World Index of 11.2%. However the result was respectable placing Alliance in the second quartile of global trusts. The charge ratio declined to 0.6%. The portfolio remains 98% equity orientated.We applaud the team’s emphasis on sustainable growth opportunities, strong corporate governance and dedication to shareholder returns.

Source; Fidessa plc

Key Risks to Price Target

i) Alliance Trust is subject to capital market movements and uncertainties relating to the UK, such as the General Election in May 2015.

ii) Sensitive to changes in the discount to net asset value per share and charges ratio.

iii) Sensitive to changes in key management personnel.

 

Britvic (BVIC) BUY

Britvic is a leading branded soft drinks businesses in Europe with own brands including Robinsons, Tango, J20, Fruit Shoot, Teisseire and MiWadi. Britvic also sells PepsiCo drinks including Pepsi, 7UP under licence. During 2014 the Britvic Group sold over 2bn litres of soft drinks (+1.5%) with an average realised price of 63p (+1%). Britvic and AG Barr attempted a merger in 2013 which was eventually terminated despite obtaining clearance from competition authorities.

Company Britvic
Share Price 739
Target Price 850
52 Wk Hi/Low 776/610
Shares O/S 248.16m
Market Capitalisation £1.83bn
Avg Daily Volume 193k
Dividend Yield 2.82%
Key CatalystsAfter an ok Q1 (group revenue £304.3m – 0.4% the focus is on recent growth initiatives in France and Ireland (c.28% sales) and ongoing cost reduction initiatives. The board need to maintain EPS momentum – adjusted EPS rose from 35.2p in Fy2013 to 41.8p in FY14 with a forecast rise to 46.04p in FY15.The failure of the AG Barr merger in 2013 due to disagreement over terms has led to a “bid premium” in Britvic possibly worth around 100p per share. Britvic is a likely consolidation within the beverage sector.

Source; Fidessa plc

Key Risks to Price Target

i) Britvic operates in a highly competitive sector for soft drinks in the UK and Europe.

ii) Sensitive to recurring speculation regarding a takeover for Britvic due to its high value brands

iii) Britvic valuation at £1.85bn is c. 22.4x net assets

 

Capital & Counties (CAPC) BUY

Capital & Counties (“Capco”) reported significant increases in the valuation of both Covent Garden (£1.6bn +25%) and Earls Court (£1.2bn + 18%) with total net assets rising to 311p or £2.63bn.The business has low gearing of 12% with available cash of £655m ahead of the build of the Earls Court properties in 2015-17. The board have employed mainly equity financing and raised £258m in May via a share issue at 340p which increased issued share capital by 9.99%.

Company Capco
Share Price 398
Target Price 500
52 Wk Hi/Low 415/315
Shares O/S 840.1m
Market Capitalisation £3.35bn
Avg Daily Volume 1.85m
Dividend Yield 0.38%
Key CatalystsCapco development plans will shortly start the Earls Court build phase in earnest with Phase 2 at Lillie Square. This scheme has progressed from planning, to enablement extends over 70 acres is consented to provide 7500 new homes.Ahead of March 23rd prelims the expectation is for further valuation growth, as both Covent Garden and Earls Court benefit from new launches partially offset by the 10% equity dilution.

Source; Fidessa plc

Key Risks to Price Target

i) Capco is exposed to west and central London property valuations and the availability of finance for residential property.

ii) Capco shares trade at a premium to net assets of 311p per share reflecting perceptions of value creation that might prove unrealistic.

iii) Capco property valuations on its balance sheet could differ from their realisable value.

 

Debenhams (DEB) BUY

Debenhams is a UK based department store operating via a store network, the business optimises space through concessions including Sports Direct, Costa Coffee, Monsoon and Mothercare. Debenhams has increased the focus on online sales, which experienced strong growth (+28.9%) over Christmas against 4.9% growth in the shops.

Company Debenhams
Share Price 78
Target Price 95
52 Wk Hi/Low 81.6 / 57.8
Shares O/S 1,227m
Market Capitalisation £962.3m
Avg Daily Volume 3.06m
Dividend Yield 4.33%
Key CatalystsRecent initiatives aimed at cutting promotional activity, lowering stock levels and boosting average selling prices are positive catalysts for FY15 (end August 2015).Debenhams has rapidly reduced debt since its IPO from internally generated cash. There re constraints to growth in the crowded UK market. The recent acquisition of House Of Fraser suggests an interest in UK fashion brands from overseas buyers that could easily extend to Debenhams. The valuation is not demanding.

Source; Fidessa plc

Key Risks to Price Target

i) Debenhams is operating in a highly competitive sector under pressure from online stores and customer willingness to shop online.

ii) The retail sector is increasingly employing promotional methods/ customer incentives that negatively impacts profit margins.

iii) Higher interest rates and general election uncertainty may impact shopping habits over 2015.

 

Greene King (GNK) BUY

Greene King is a leading UK brewer and publican operating over 1900 pubs in the UK of which 1,000 are retail and the rest tenanted/ leased or franchised. Greene has made an agreed takeover of Spirit Pubs Group (SPT) which we expect to close shortly and boost EPS in 2016.

Company GNK
 Share Price 856
Target Price 1000
52 Wk Hi/Low 917/716
Shares O/S 219m
Market Capitalisation £1.87bn
Avg Daily Volume 0.487m
Dividend Yield 3.36%
Key CatalystsUsing a 5 year (March 2010-15) data series, and excluding dividends, Greene achieved the second highest monthly average return of 1.69%. This is due to the rising value of Greene’s £2.2bn property portfolio and its strategy shift into a “food led” offering. The Spirit Pub acquisition adds Chef& Brewer and Flaming Grills chains to Greene’s Hungry Horse and Loch Fyne chains. The combination should enable Greene to refinance expensive Spirit debt and obtain better cost synergies worth c £70m in the next 2-3 years.

Source; Fidessa plc

Key Risks to Price Target

i) Greene King business is influenced by weather patterns and spending habits that may be difficult to predict.

ii) Greene King acquisition of Spirit Pubs has yet to complete. A delay in the merger could impact the timing of expected synergies.

iii) The valuation of Greene King’s properties could be impacted by rising interest rates.

 

Investec (INVP) BUY

Investec plc is leading UK fund manager and specialist bank operating primarily in the UK, South Africa and Australia. The asset management side (£71.7bn) increased funds under management (FUM) by £3.7bn, whilst wealth & investment management reported FUM of £43.7bn v £41.5bn at the interim results on 30th September 2014.

Company INVP
 Share Price 575
Target Price 700
52 Wk Hi/Low 606/436
Shares O/S 613.6m
Market Capitalisation £3.53bn
Avg Daily Volume 1.5m
Dividend Yield 3.43%
Key CatalystsStrong US & UK capital markets should boost FUM from £115.7bn to over £125bn underpinning gains of c.10% in fee & commission income flow over 2015 (£1.13bn; 2014) and help new mandate wins.Impairments losses (£166.8m:2014) are trending lower by c.20% a positive impact for FY15.

Source; Fidessa plc

Key Risks to Price Target

i) Investec banking business is subject to normal credit risks relating to lending activities.

ii) Investec operates in a competitive global industry for wealth and fund management.

iii) Investec is exposed to currency risks relating to the South African and Australian operations.

 

Inmarsat (ISAT) BUY

Inmarsat is a satellite based telecommunications company with a leading position in marine, “ship to shore”, aviation communications and government related global satellite communications.

Company Inmarsat
 Share Price 904
Target Price 1000
52 Wk Hi/Low 904/674
Shares O/S 448.3m
Market Capitalisation £4.05bn
Avg Daily Volume 1.43m
Dividend Yield 3.28%
Key CatalystsImpressive FY2014 results, profit before tax $341.1m v $102.6m with strong revenue gains in global maritime, aviation and wholesale mobile satellite service (MSS).After significant spend on capacity expansion in FY2014 via the launch of F1 and F2 satellites, capital spending is to fall to $400m in 2016 and 2017. Inmarsat’s free cash flow should therefore improve in FY15 and FY16.

Source; Fidessa plc

Key Risks to Price Target

i) Inmarsat revenues are heavily weighted towards maritime communications making the business sensitive to the cyclical shipping sector.

ii) Inmarsat has significant costs relating to launch and maintenance of its satellite communications infrastructure.

iii) Telecommunications pricing is highly competitive.

 

Rexam (REX) BUY

Rexam has agreed to be acquired by Ball Corporation (NYSE: BLL) on attractive terms that comprise: 407p cash + 0.04568 BLL shares + dividends in respect of each six month period between the announcement and completion. Rexam has already declared an 11.9p dividend and we expect the time frame to completion (expected in H1 2016) will be sufficient time for the interim payment as well- this should be 5.8p in September.

Company Rexam
Share Price 555
Target Price                     635
52 Wk Hi/Low 569 / 425
Shares O/S 704.96m
Market Capitalisation £3.92bn
Avg Daily Volume 3.2m
Dividend Yield 3.16%
Key CatalystsThe excitement of the takeover announcement was tempered by conditions relating to the acquisition, notably competition clearance in the EU, Hart-Scott-Rodino (US antitrust legislation) clearance and a lengthy timeframe.The merger terms value Rexam at c 639p per share hence a 15.2% return for investors willing to take the “deal risk”. In our view merger clearance with conditions is likely which could involve the terms being tweaked slightly.

Source; Fidessa plc

Key Risks to Price Target

 i) The merger may be terminated in the event of competition authorities concluding the merger reduces competition.

ii) The timeframe to completion of the merger is approximately one year hence a significant time horizon during which valuation issues may occur

iii) Rexam has flagged a tough trading environment which may impact the share price of Ball Corporation and the value Rexam shareholders receive.

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