John Stepek and Tim Bennett look at the sectors to buy into in 2008 – and, below, which ones you should steer clear of
GM food
While the credit crisis hogged most of the business headlines last year, the rising cost of food snagged its fair share of column inches as it finally became a mainstream concern.
And little wonder. According to The Economist, global food prices were up by 42% in the year to 17 December, driven mainly by a growing middle-class in Asia consuming more meat, and the misguided expansion of the US ethanol programme, which sucks up vast quantities of corn to create biofuel. While the latter problem could be solved by scrapping ethanol subsidies, the former is unlikely to go away quite so easily.
But amid all the agonising about population growth, and the wild card of climate change, one potential solution stands out – genetically modified food. In the UK, GM has something of a bad reputation owing to fears over potential negative effects on the environment. But outside of Britain and Europe, GM crops have been an “astonishing success”, as Dick Taverne, author of The March of Unreason, wrote in Prospect recently.
Pest-resistant GM cotton is grown across India and China, while more than half the crops grown in the US – “including nearly all the soybeans and 70% of the corn” – are genetically modified in some way, says Brian Hindo in BusinessWeek. The benefits are straightforward: hardier crops mean higher yields, while farmers can save money by using less insecticide.
As concerns grow about the impact of food costs, objections to GM will look more and more like European elitism, particularly as so far “there is not a shred of evidence of any risk to human health from GM crops”, says Taverne.
That’s good news for one stock in particular, Monsanto (US:MON). The group gets around 60% of its revenues from biotech seeds, says Hindo. Mark McLornan of Agro-Terra reckons it could become the “Microsoft of agriculture”. The only snag is that the stock currently trades on a pricey forward p/e of 44, but as the top player in a growing field, it’s one to buy on any setbacks.
Meanwhile, a slightly less pricey option, trading on a forward p/e of 24, is Syngenta (US:SYT), which makes 20% of its sales in GM.
Hong Kong property
With the US housing market stuck in the doldrums and the UK’s looking sickly, investors could be forgiven for avoiding property altogether. However, there are still some corners of the globe where real estate looks good value – and one of them is Hong Kong. In fact, Chris Woods of CLSA describes the residential sector as being “on fire”. What’s going on?
All the ingredients for a sustained boom are present on Hong Kong’s tiny main island. Unemployment fell to 3.6% in the three months to November (its lowest level since 1998), reflecting the fact, says Francis Lun at Fulbright Securities, that the economy is “growing healthily”. Interest rates are falling and, partly as a result of this, plus recent food price rises, inflation jumped close to a nine-year high in November – a combination that bodes well for property as an inflation hedge.
Property agency DTZ reports that office rents in central Hong Kong climbed 28% in the first nine months of 2007, luxury home prices are already close to their previous peak in 1998, and the property sub-index of the Hang Seng has jumped 52% so far this year.
So, where will the best gains come from in 2008? Woods likes the mass residential market, where he expects a supply crunch that could induce a “full-scale buying panic” next year, as huge numbers of homeowners hoping to upgrade collide with a shortage of new-build flats.
Crucially, unlike the luxury end of the market, prices for the mass market are still around 40% below their 1997 peak and affordability is high – mortgage payments as a proportion of household income are at 33% compared to 93% in mid-1997.
There are risks, of course – a total collapse in the US economy rippling across the Far East, or the recent trickle of expatriates heading to less polluted Singapore turning into a flood. But both seem unlikely for now. You could buy into the general property sector through a real estate investment trust such as Link Reit, but a better way into residential property in particular might be estate agency group Midland (HK:1200) which trades on a forward p/e of 24.
Debt collectors
The New Year promises to be anything but happy for the majority of consumers. Mortgage costs are set to rise at the same time as house prices falter, while energy and food bills are only going to get dearer. The Council for Mortgage Lenders expects the number of repossessions to rise by 50% to 45,000 this year, while Capital Economics reckons that bankruptcies will hit a record of more than 115,000.
It’s not just a British problem. In Europe, the Irish and Spanish economies in particular have been buoyed by house-price bubbles that are now bursting, while in the US, consumers are wilting under the worst housing collapse since the Depression.
This squeeze on the consumer will be bad news for most companies as more and more customers struggle to repay bills. But one group should benefit: debt collection agencies, which buy bad debts cheaply from firms and then pursue collection, profiting by collecting more than they paid for the debt.
It’s a highly fragmented industry, but Swedish-listed Intrum Justitia (Stockholm:IJ), which has 10% of the market across the 22 European countries in which it operates, is worth a look. It trades on a forward p/e of 20.
In the US, Portfolio Recovery Associates (US:PRAA) is the leading listed pure-play debt collector. It trades on a forward p/e of less than 13, which looks cheap, given the price-to-earnings-growth ratio of 0.87.
The sectors to avoid
Commercial property
The UK housing crash has only just begun, but 2007 already saw the bursting of the commercial property bubble as sales dried up in the wake of the credit crunch. Investment Property Databank estimates that capital values in the UK fell by 4% in November alone, the largest monthly fall ever recorded.
Last month, Friends Provident stopped retail investors in its £1.2bn flagship fund from cashing in their holdings for up to six months in an attempt to stem a mass exodus by those now worried after having been seduced by several years of double-digit returns.
With Citigroup reporting that FTSE 100 property stocks have fallen by 50% on average this year, some are eyeing the sector for potential bargains – but we’d steer clear for now. The bad news for the sector is far from over and sentiment could get much worse. Consultancy Capital Economics reckons that prices will fall by at least 15% to mid-2008, “but larger falls are certainly possible”.
The leisure sector
According to consultancy Footfall, 25% more people went shopping on Boxing Day this year than last year. Meanwhile, internet research group IMRG reported a 269% jump in online sales on Christmas Day. But don’t be fooled – look beyond the Christmas period and pressurised consumers are already cutting out “non-essentials”.
As the FT observes, that’s bad news for businesses, from cinemas and hairdressers to hotels and travel agents. The latest CBI/Grant Thornton survey shows that in the last quarter of 2007 demand for “consumer services” dropped at the fastest rate in its history.
December saw profit warnings from restaurateur Clapham House Group and pubs group Regent Inns. Pubs are under particular pressure as a noxious cocktail of falling property values and rising commodity prices – a pint of beer could cost up to 60% more in 2008 due to soaring wheat costs – will hit hard in a sector that has already suffered share-price write-downs of 25% to 50% in 2007.
The outlook is also rocky for hotel groups such as Accor SA (Europe’s largest lodging company) and Whitbread, and for the travel industry – TUI Travel announced capacity cuts of 12% in November and Thomas Cook slashed the former Mytravel holiday programme by 23%.
Banking
Following the marking down of banking shares in the wake of the Northern Rock fiasco, optimists think they see a buying opportunity among the UK’s retail banks. The shares certainly look cheap with dividend yields at a historically attractive 5.2%.
But piling in to the likes of Barclays and Royal Bank of Scotland now could well be a costly mistake. Firstly, the subprime crisis has some time to run. European and American banks have already written off more than $50bn on securities linked to subprime mortgages, but this may be just the tip of the iceberg – losses could reach $400bn worldwide, say some analysts.
Next, there’s the lack of revenue growth – personal insolvencies are set to rise in 2008 according to Grant Thornton, and lending criteria are continually being tightened for anyone with a less-than-perfect credit history.
As a result, loans made for house purchases are diving – mortgage approvals dropped 44% in November compared with a year earlier, according to the British Bankers’ Association, and unsecured borrowing is on the wane too.
Meanwhile, to shore up balance sheets blasted by bad debt write-downs and maintain capital ratios, retail banks will have to attract and retain savers by offering competitive savings rates, which will further dent profit margins. So overall, while bank shares may look cheap now, we think they are about to get cheaper still.