The bullish case for UK equities
Brexit, sterling’s fall from grace, the collapse of the London housing bubble and the fractious politics of Theresa May’s Tory government in Westminster has made UK equities a pariah for global asset allocators.
British equities exhibit metrics of investor pessimism last seen just after the epic failures of RBS, Lloyds HBOS and, yes, Barclays PLC in October 2008. The financial markets have derated the FTSE-100 index from 16 times earnings in to a mere 12.8 times forward earnings now even though the index companies derive 72% of their revenue outside the sceptered isle. This is surreal and one of the great valuation arbitrages in global equities.
British equities are now trading at their lowest levels since the Cameron – Osborne era circa 2014. My favourite stocks on the Footsie index include Shell, Anglo-American, GlaxoSmithKline, Shire PLC, Lloyds Banking Group and Barclays. BP owns 19% of Russia’s Rosneft and is thus vulnerable to the Kremlin’s retaliation. Each one of these British blue chips is a turnaround/story stock mispriced relative to its earning potential and franchise value. I believe sterling is still undervalued at 1.39 and that the “hard Brexit” risk premium demon that haunts the City of London will be exorcised by events. Sectors to avoid? Retail. Tesco, Sainsbury, Marks & Spencers.
Britain will continue to trade at a discount to Wall Street due to Brexit and the Footsie 100 index’s megacap low multiples energy/metals shares. There has been a brutal derating in British banks and Barclays, a historic High Street Quaker clearing bank whose pedigree goes back three centuries to the early Georgian era, trades at all of 0.6 times tangible book value.
I expect fund managers will eventually realise that the FTSE-100 index should be rerated, not dissed, amid a synchronized global economic expansion. UK Companies, ironically, generate higher operating profits than their peers in France or Germany since they do not have rigid, Stone Age labour markets dominated by trade union (Queen Maggie vanquished the Gorgon Scargill in 1984!) and regulatory burdens yet command a lower valuation. I concede that consumer confidence has plummeted since Brexit and the rise in food/petrol prices will hit consumer spending. Yet Unilever, Diageo, BAT and Reckitt and Coleman are global, not just Little England, brands.
‘I would avoid UK retailers and homebuilders like the plague’
Still, I would avoid UK retailers and homebuilders like the plague. British Land trades at 30% below its net asset value. This only tells me that the stock market just does not believe the appraised value of Britain’s pre-eminent commercial property landlord.
UK banking is a classic valuation rerating candidate due to a steeper gilt yield curve. Mark Carney will the base rate in May and November due to inflation risk and Fed rate hikes. The end of the litigation cycle (PPI, LIBOR manipulation, mortgage securities fraud) and higher loan growth will boost the returns on equity and free cash flow of UK banks.
Energy and mining are 26% of the Footsie’s index at a time when I am bullish on UK names in these global sectors. This is the global macro milieu in which Rio Tinto, Glencore, BHP and Anglo-American rerate and I am also bullish on both BP and Royal Dutch Shell. In the stock market at least, cool Britannia lives on!
Share buybacks will also be a positive catalyst for UK equities in 2018 as they almost equal the 17 billion pounds in 2017 new equity issuance.
‘In the stock market at least, cool Britannia lives on!’
Note that Lloyds announced a 1 billion pound share buyback plan last month and Royal Dutch Shell plans to spend $25 billion in share buybacks until 2020.
Even Aviva plans to buyback 500 million pounds in preferred shares. This alone suggests UK boards believe their companies are undervalued relative to global peers. Share buyback are also correlated to anticipated rises in earnings and cash flows, surely a fundamental ballast for a British equities rerating in the year ahead.
The metrics of relative valuations between London and New York also tell me that the “Brexit discount” is excessive and unrelated to corporate fundamentals.
Britannia no longer rules the waves but definitely rules the air waves, at least to this fan of FM 103.8!
The Kremlin and Downing Street now face off in the most serious geopolitical confrontation since the end of the Cold War. The Russian secret service has been active in London since the Tsarist Okhrana hunted dissidents in the East End in the 1870’s. The influx of post-Soviet oligarchs in Mayfair, Belgravia and South Ken made Londongrad prime property white hot since the 1990’s. No longer!
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