Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Peter Lees of the F&C UK Equity Fund.
The UK market has been very resilient, given the three major headwinds it has faced – the tragedy in Japan, the ongoing sovereign-debt crisis in Europe and revolution in the Middle East. Individually, firms continue to post healthy profits with reasonably upbeat statements about the future. As such, the market still represents reasonable value. Earnings have kept pace with price increases and the price/earnings (p/e) ratio for the British market is currently just over 11. This is low compared to recent history. However, that reflects a strong earnings recovery (faster than share prices) and the increased risks in the market associated with the debt crisis. We believe the UK equity market offers real value when compared to other asset classes.
Our focus is on firms that can prove they are enjoying increasing sales on the back of raised investment. Those with good management and the right products are beginning to differentiate themselves. The market is shifting from a credit-crunch recovery phase – during which most assets have performed well – to one where sustainability of earnings driven by sales takes precedence. Stock selection is therefore crucial. The wider market won’t enjoy the same strong returns as it has had over the last two and a half years, but single stocks should outperform.
We continue to like speciality chemicals business Croda International (LSE: CRDA), which has just produced another set of sparkling results. The firm has again proved that it can pass on rising costs to the end customer and increased market share, leading to excellent cash returns. It is becoming a truly global business and new growth opportunities are more apparent. Its agricultural business, for instance, is beginning to make significant progress. The board can now choose where to allocate capital expenditure, which is a great position to be in. The yield is over 2% and, although the firm is on a relatively high multiple, we expect further upgrades.
We also like investment company Melrose (LSE: MRO), particularly as the directors have sorted out their acquisition of engineering conglomerate FKI. Margins and return on equity have never been higher. The directors are also in the process of disposing of Dynacast and we anticipate the vast majority of the proceeds will be returned to shareholders. The directors are seeking another significant acquisition and we trust them to execute it as well as they’ve done in the past. Another clear statement of the firm’s robust health was the very generous recent dividend given to shareholders. Compared with their immediate peers, the shares remain good value with a yield of 3.5% and a p/e of just over 11.
A relatively recent purchase for us has been home improvement retailer Kingfisher (LSE: KGF). We think the market valued this business’s cash flows too cheaply. You don’t have to be a genius to see that life on the high street is difficult. But at the same time there is a price for everything. That price becomes more attractive when management can demonstrate that it is making real progress even in the most difficult of trading circumstances. The advantage that Kingfisher has over immediate peers is an evolving international business plus increasing control of its supply chain. This means that the board can grow gross margins and put investment into the business. Kingfisher yields 2.8% and is on a p/e of about 12.5.