Paul Hill, one of Britain’s most successful private investors, picks the best share tip from the week’s press and broker reports. This week: the City may have been put off by a cautious 2007 outlook, but this financial stock has good long term potential.
Tip of the week: Old Mutual (OML), upgraded to BUY by Citibank
Last Wednesday, Old Mutual’s (OML) share price jumped by 2% to 170p, after Citigroup upgraded the stock from hold to buy, with a 188p price target. Old Mutual is a member of the FTSE 100 with a £9.4bn market capitalisation. It offers life insurance and asset management services in South Africa, Europe and America and also has interests in retail banking.
Last year, the firm bought Sweden’s Skandia for £3.3bn, giving it a much stronger global footprint. About 50% of its 157p adjusted embedded value – a key measure of a life insurance company’s worth – is derived from South Africa, with the rest now coming from Europe (30%) and the US (20%). In light of the size of the Skandia deal, 2006 was a year of integration. Underlying operating profit was up 16% to £1.46bn from £1.26bn in 2005, generating earnings per share (EPS) of 15.1p, with the dividend rising by 14% to 6.25p, representing a chunky 3.7% yield. This was achieved despite a headwind from adverse foreign exchange movements that sliced 1.2p off EPS.
However, the City has been worried by a cautious 2007 outlook statement, which said that exchange rates and continued investment in its European and South African businesses would hold back earnings growth this year. But in the longer term the chief executive, Jim Sutcliffe, is upbeat on prospects, adding that “the £70m per annum of cost savings from the Skandia acquisition and the target of hitting £300bn of funds under management (FUM) by 2008 were both on track”. Reassuringly, FUM rose 31% in 2006 to £239bn, while up to 800 job cuts have been identified in the group.
Clearly, the company still faces a number of challenges. Firstly, there is the ongoing currency volatility, increasing competition and geopolitical concerns in South Africa – albeit the local economy grew an impressive 4.5% last year on the back of a buoyant mining sector. Furthermore, Old Mutual does have some exposure to the problematic US subprime lending market, although this only represents around 3% of its US bond portfolio. Lastly, there are risks over its credit rating – Moody’s placed its debt (net £2.4bn) on negative watch in February 2006 – together with normal investment exposure within its fund management units.
Nevertheless, I believe this is taken into the valuation and the stock offers good value for the patient investor. Citigroup is forecasting diluted EPS of 16.1p and 18.2p respectively for this year and next, putting the shares on corresponding p/e ratios of 10.7 and 9.4.
Recommendation: LONG-TERM BUY at 170p
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