Every month, we invite the best investors we know for drinks and ask what they would put their money into now
Merryn Somerset Webb: Let’s start by talking about the UK market. How do you see 2007?
Steve Russell: I see a market with extraordinary amounts of liquidity pumping into it with private-equity bids left, right and centre. But this year, I also see slowing earnings growth and a high risk of a major setback to markets. I think there’s a fair chance the markets will see a 30% fall at some point – not necessarily this year, maybe the year after – it’s hard to time. With so much debt flying around, world markets are an accident waiting to happen.
MSW: But what will trigger disaster?
SR: Perhaps a credit derivatives event of some kind or the slowdown in the US housing market feeding through to create a wider global slowdown.
Jim Mellon: I’m fairly pessimistic about the macroeconomic situation too. This time last year, I thought we would see a period of inflation caused by rising commodity prices – and we’ve got that. Like Steve, I also thought, and still do, that a major event will hit markets – one that we just can’t forecast with any accuracy, but which will be precipitated by huge levels of debt in the markets. On the other hand, however bad things look from a macroeconomic point of view, there are lots of individual opportunities that are worth buying into. I was wrong to be so pessimistic last year and I think it’s a brave man who calls a downturn now. There are lots of risks, but we just don’t know how and when they will play out.
Sebastian Lyon: That’s the thing. We know there is a risk of a credit crunch; we know there is risk in the derivatives market. Warren Buffett has been writing about this for years, but clearly he can’t time it. And if he can’t, none of us can. We’re feeling very cautious at the moment, but I agree that there are opportunities out there. I think there’s good value in UK large-cap stocks, for example. FTSE 100 stocks are now the cheapest on a p/e basis that they have been for 15 years – 12/13 times for next year. If we see a major slowdown in the US, clearly earnings aren’t going to be as good as forecast, but those valuations still give a degree of comfort. It’s not like buying in 2000 – then, p/es were 20 plus. We aren’t expecting to see huge returns in 2007, but it should be fine. It’s a matter of being in safe assets.
Andrew Green: I think it’s a mistake to get too pessimistic about the global economy just because of the unwinding of the housing cycle in the US. Unlike 20 or even ten years ago, there are now other drivers of growth that can keep the show on the road as the US slows. I know there is a great deal of interlinking in the global economy, but there are signs of recovery in Europe and the UK is doing fine. China and India also look OK and Japan is showing some signs of growth. So US earnings growth can continue. That said, I don’t see the FTSE 100 as necessarily cheap. About eight stocks in it are cheap – the rest aren’t. The mean p/e of the UK market may be 12/13, but the median is more like 15. And the shares that look cheap, are they really? Is BP cheap? I don’t know. If someone can tell me what the oil price will be in two years’ time, I’ll tell you whether it’s cheap or not. Is Glaxo cheap? Is it going to discover another blockbuster drug? I don’t know, maybe not. It’s more complicated than it looks.
Marina Bond: I think quite a lot of stocks on Aim look reasonably cheap. Aim has had a bit of a tough time recently – it’s still 18% off its peak – and there have been a lot of less high-quality floats. But if you take out some of the hit-and-miss oil, mining and exploration stocks and the colourful concept stocks, there is value to be had. Ignore the firms not making profits and the forward p/e for Aim is around 14 times, even though earnings are forecast to grow at around 30%. Clearly, you can’t rely on that growth – it may be more like 20%, but 20% is still good.
MSW: So value in small and in very big?
Andrew Jackson: What is clear is that, in the mid caps, there is less value. The huge number of mergers and acquisitions has really pushed their prices up too high. What might surprise us this year, though, is a very large bid among the mega caps. It might not be in the UK, but as the UK is one of the cheapest markets, it could be.
MSW: When you say very large, what sort of company do you mean?
AG: Vodafone.
SL: BT – or any of the big European telecoms. The fundamentals may look shocking, but the cash flow is great.
MSW: What about the big oil companies in the UK? They’re cheap. Are they safe?
AG: I think they are cheap for a reason. They aren’t replacing their reserves, so they can’t keep producing their current volumes long term. Shell has had high-profile problems with Sakhalin Energy, but its other projects are also high risk, or in dubious jurisdictions – goodness knows what the future of Nigeria is, for example. Even if you think the oil price will stay high – and the current price seems about right to me – there are better ways in.
MSW: And will it stay high?
SL: I think that in 12 months’ time, it will be much as it is now. Opec is showing a bit of discipline. I can’t see Iraq becoming a huge exporter in the next year and Russia is pumping at pretty much maximum capacity, so there is no new source of supply around.
MSW: So how should we be investing?
AG: Anything in liquid natural gas (LNG) is a good place to be. There may be demand coming from Asia, but that’s not where the raw materials are. That means that anything to do with transportation, liquid natural gas terminals, shipping and so on are good bets. In the UK, you’re better off owning BG Group than BP. BG may be trading on premium, but it’s got growth and quality assets.
SL: We’ve been underweight oil for a while, but we’ve recently been adding BP. It is unloved and ignored, but generates very good dividends. Soon, the market might begin to recognise the value there.
JM: I’d buy uranium. Nuclear really is the energy of the future and uranium is in very short supply. A lot of the uranium supply over the last 15
years has come from weapon decommissioning – there has been almost no new exploration. Now, though, the stockpiles are gone and the big mine that was supposed to be opening in Canada in two years’ time, Cameco’s Cigar Lake, is flooded and out of action. Yet at the same time, China is building a lot of nuclear power stations. I think there are 40 underway. We are also going to have to build more nuclear power stations in the West over the next 15 or 20 years.
SR: I think uranium is a great story; I just can’t deal with the volatility that comes with it – it goes up 70% and then falls 40%.
JM: It’s the only solution to global warming – the only one! I am chairman of Aim-listed uranium company UraMin. The shares have risen a lot, and I think they still make a good investment.
David Fuller: I would still look at Cameco. There’s a lot of uranium in Cigar Lake. It is flooded, but the resource is there and I imagine the technology to get it out will be found.
MSW: What about other commodities?
AG: I’m bullish on commodities long term, but you don’t have to go far
down the finished goods chain to see worrying trends – in steel, for example. China used to need to import large amounts of steel, but now it can produce its own. I think that, with supply rising, we are going to see
prices falling in a classic steel cycle
over the next two years. I wouldn’t go near anything involved with the manufacture of steel.
DF: All commodities have always been inherently volatile and I would expect that to continue. When we last had a genuine commodities bull market in the 1970s, the US, Europe and Japan were the only ones creating the demand. China and India weren’t on the radar and South America was a mess. But today, all those other countries are doing pretty well. Who isn’t building infrastructure today? We’re not just talking about Asia, but the Middle East and South America too – look at it and you’ll see that there has never, ever been anything like this before in terms of demand. Clearly, capacity is going to go up, but don’t forget that until the last few years we had a savage 21-year bear market in commodities, a bear market that has wiped out a generation of expertise in the mining industry. People have been leaving it in droves and no one new has been trained. It’s taking a very, very long time to catch up. Add to that the fact that lots of the minerals and metals we need are located in kleptocracies, which are seizing the stuff and then not producing it efficiently, and it’s clear that supply is inelastic. In the past, everyone has looked at big mining companies as being hugely cyclical. But things have changed – thanks to capitalism and globalisation, these are now growth stories.
AG: Still, shorter term it is quite clear that some of the metals have been getting overblown. It’s all very well saying there haven’t been any big discoveries for 15 years – there haven’t – but technology means you can get more out of each mine. There are things you can do in the short term, so most forecasts for copper supply, for example, are running slightly ahead of demand for next year.
JM: But most of the earnings estimates for 2007 – the ones that are giving the big mining firms single digit p/e ratios – are based on metal prices that are considerably below current prices. So a 30% fall in prices wouldn’t change the earnings estimates or surprise anyone.
MSW: Jim, what do you see as safe assets at the moment?
JM: Well, I love German property. It’s still selling at well below replacement cost and it’s a big liquid market you can get into quite easily. It’s been in a bear market for 17 years – it’s been even worse than Japan – but I think we’re in a ten-year bull market on German property. To me, that’s a very safe asset – as long as the Germans pay their rents, of course. I also think Macau is safe: there’s no stopping it from becoming three times bigger than Las Vegas as a gambling destination. In Macau, you can invest in the gambling company Melco PBL Entertainment (MPEL), or you can invest directly in property. For German property, there are a number of funds on the London market – we hold Speymill (W2N), for example.
MSW: Isn’t the problem with German property the very low yields?
JM: That’s both a problem and an opportunity. Germans, on average, are spending only 20% of their disposable income on rents or mortgage payments and, in a city like Berlin, 80% of the population are renters, so obviously there is an opportunity in buying property and converting tenants into owners. But it is also possible to get rents up. You can raise rents by 20% over a three-year period. And when you’re borrowing 90% loan-to-value ratios, which is what we are doing on some of our portfolios, the leverage effect of doing so is tremendous. Thanks to low prices, there has been no new construction in Germany for the last ten years. But there is a rising population and a rising demand for homes – there is just a tremendous demographic push, which I think ultimately means rising prices and rents. These funds are going to pay 6%-7% yields in the next year.
MB: It makes sense, but so many funds are chasing German property that some are having difficulty investing their cash.
JM: That’s true. There are lots of issues people didn’t think about properly when they started out – the tax implications and how the financing works best. But the fund we launched last April will be fully invested by February, so it can be done.
SL: We’ve bought shares in Puma Brandenburg, which is a mainly Berlin-based fund. The fund won’t be fully invested as quickly as Jim’s, but it won’t take much longer.
MB: Do you think the imminent rise in VAT in Germany will have an impact?
JM: A bit, but the momentum of the economy is positive at the moment, so I’m not too worried. We are seeing about 3% growth in Germany this year – that’s the first time it’s going to exceed UK growth for 15 years – and I think you will still see 2.5% growth next year. Germany is a powerhouse – it’s a very diversified economy in much better shape than ours.
SL: We’ve also got a good play on German consumers: it’s called Hawesko (HAW) and is basically the Majestic Wine of Germany. It has a decent chain of 200 wine stores, but also exclusive rights to distribute a number of international brands. It yields 4.5% and, while it isn’t big, it’s got a steady track record and is doing well out of the middle-class shift from beer to wine drinking.
DF: I’d look more to Asia for my favourite markets. Germany is the class act in Europe, but it is still a slow growth area – as is the US. It’s kind of ridiculous that we think of America as the engine for the global economy when that role has really been taken over by Asia, with its much bigger population. My three favoured markets for the very long term are India, China and Vietnam, which has embraced capitalism with a vengeance. China also looks fine short term – to save face, they are going to want to go into the 2008 Olympics with one of the very best-performing stockmarkets. But China’s authoritarian capitalism does bother me and I see trouble there at some point. Vietnam is managing the transition to capitalism with a lot more flexibility.
I think South Korea is a major play and Taiwan ought to be a recovery candidate, given that it has been a dud for so long.
SR: If you think there is a US slowdown coming, then you have to think China (given how much of its economy is given to exporting) will be one of the worst hit. That’s not to say that China is not on a long upward march, just that its market could quite easily halve in between.
JM: In China, unlike in Russia, you can make plays through foreign enterprises. Russia is an expropriating kleptocracy. Invest through foreign companies and you are going to end up losing money. If you’ve got an attractive asset, they are going to steal it – that’s my view. So you have to buy local stocks. In China, that’s not the case – it’s entirely possible to buy into the country’s growth via foreign firms that are operating there.
AG: What I wouldn’t do is buy the Aim-listed Chinese companies. A lot of them have listed at the wrong price and you also have to wonder why they are listing in the UK and not in their own country – or at least somewhere where their business is understood. We’ve been invested in China for years, but we tend to do it through Hong Kong instead. There’s a lot of rubbish listed on Aim that is there simply because it wouldn’t be allowed to be listed anywhere else.
MSW: Has anyone got a top tip for 2007?
MB: I want to tip a stock I tipped last year, called Renew (RNWH), a specialist construction company that’s off most people’s radar. It is small, but it’s a turnaround story – new management came in last year and has been focusing on areas such as nuclear decommissioning and social housing. Renew has lots of cash and has still got some asset disposals to make at some point in the future, yet it is on a p/e of only eight times.
AG: My tip is a bit of a punt, but a large punt: the most shorted stock in the FTSE 350, Carphone Warehouse (CPW). Most people hate it, but I believe the market has got far too carried away on two counts. One is this change of relationship with Vodafone in the shops. In fact, the only thing Carphone Warehouse can’t do now is sell a non-Vodafone customer a Vodafone phone. If you are already a Vodafone customer you can still get the whole range and if you aren’t, you can get it all except Vodafone – which really isn’t that big a deal. Most of us don’t care what network we’re on, we just want the right handset, functionality and price. Carphone Warehouse is still the market leader and its retail business will carry on growing. The second issue the market has been far too spooked by is the broadband business. Obviously, this is cut-throat, but Carphone Warehouse’s broadband is cross-subsidised by a very competitive voice offering and no one else has that. Anything that’s hated this much, that is the most shorted stock in the UK stockmarket, and that is only on a p/e of 12 times, is worth looking at.
SL: I’d like to go for Puma Brandenburg (PUMA) and Hawesko (HAW), as mentioned earlier.
SR: I’m going for Unilever (ULVR) and GlaxoSmithKline (GLK). With Unilever, you can practically buy an almost index-linked stream of income. The shares currently yield 3.6%, but there is a new chairman coming in and I think it will also get the benefit of food inflation coming through. As for GlaxoSmithKline, I just can’t believe people can hate a stock as much as they hate this. It is yielding 4% and, even if it doesn’t find another big drug, we need the ones it’s got. There’s also lots of scope for cost cutting. The market is refusing to notice value here.
AJ: I’m going to go for an Aim-listed property developer called Dolphin Capital Investors (DCI). It’s raised a large pool of money to develop integrated golf courses and upscale resorts. Apparently, southern Europe has 200 to 300 golf courses and Greece only 20 – there’s huge scope for growth and the Greek government is keen to encourage it. The guys who run Dolphin are buying property at below market rates, partly with the help of the Greek Orthodox church, which is quite open-minded on this sort of thing. They get planning permission on it and substantial uplifts along the way.
DF: I’ll go for Rio Tinto (RIO). Then I’ll go to Japan for something totally different; I’ll go for Toshiba (TOSBF). I think they will make a fortune with Westinghouse through their nuclear contracts.
JM: My punt for the year is called Billing Services Group (BILL). It ran into some trouble a few months ago, management turmoil and so forth, but it’s one of the largest processors of phone bills in the world. It does the interconnect phone billing between Vodafone and Orange, for example, and has 1,200 telecoms customers. However, the reason I’ve bought a large stake in it is because I think there is going to be an explosion in micro-payments (using mobile phones to pay for things, for example), so there is going to be a dramatic requirement for processing capability. The company’s market cap is low because it is very highly leveraged, but it is generating good free cash flow on its long-term contracts and it’s a very attractive proposition for the micro-payments business. We’ve got 11-12% of it.