Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Daniel Hanbury, manager of the River and Mercantile UK Equity Income Fund.
After three to four years of low volatility in the markets, we saw a sell-off in the third quarter of 2015 – and it has thrown up some very interesting investment opportunities. Standard Chartered (LSE: STAN), for example, has suffered as a result of the general pessimism about China and emerging markets.
Until recently, Standard Chartered was a standard-bearer in the march into emerging markets – it was one of the highest-growth banks with exposure to emerging markets, primarily in Asia. The bank was valued at around three times its tangible net asset value and had a consistently high return on equity. It was re-investing for growth at a prodigious rate.
Now, however, it’s a different story: the shares have underperformed for five years and have fallen 45% in the past year alone. As of the time of writing, the bank is trading on 0.6 times its tangible net asset value and is as such arguably pricing in a scenario at least as bad as the Asian Crisis of 1998, which started with the devaluation of the Thai baht in 1997 and ended with the IMF bailout of Indonesia in March 1999.
One of the greatest threats for banks is when their loans start to turn bad just at the point they are growing their loan book most strongly. In 1996, only 0.3% of Standard Chartered’s loans were impaired (ie, the bank was not collecting amounts due). The number of loans it issued (its loan book) rose rapidly as the bank grew. But the impairments grew too, ultimately to more than 4% at the height of the Asian Crisis, a time when Asian currencies were falling by 40%-50%. (Note – a bank’s highly geared balance sheet means that 4% is likely to wipe out a significant chunk of your equity value.)
Fast forward to 2014 and the bank’s markets were already slowing significantly, it was shrinking its loans and last year 0.7% of its loan book was impaired. Analysts now forecast an additional 2.9% of loan impairments for the 2015-2017 period, a total of almost 3.6% at a time when it has been looking to lower the risk of its loan book for several years already. That looks bad, but the shares are very cheap. Share prices reflect future expectations – but if the very low expectations priced in improve even modestly, the shares could rise sharply.
Food and drink retailers have also been out of favour recently, and we have backed small-cap bargain-booze specialist retailer Conviviality (LSE: CVR) following its acquisition of Matthew Clark, which was the largest independent drinks distributor to on-trade premises such as restaurants, bars and hotels. Cost savings, complementary distribution and improved buying power for the combined group are significant. The deal is predicted to give a 40% boost to earnings, but our models suggest management and analysts are being conservative in their current assumptions, and that figure could be higher. The shares are undervalued on conservative assumptions.
Finally, we do occasionally look at IPOs (when a company first sells shares on the stock exchange) when we think companies are being sold with strong growth potential at a reasonable price. On The Beach (LSE: OTB) specialises in online, short-haul, packaged beach holidays. We believe its nimble model and innovative in-house technology and mobile marketing is resulting in strong growth, which is currently undervalued by the market.