Five stocks to follow in 2015

Monday, 12th January 2015 14:31 - by David Harbage

Following on from the 'Looking Forward into 2015' article, the writer was asked to provide five stocks which are likely to benefit from the anticipated economic climate or merit special attention in the coming year.

Before discussing the potential themes - and identifying appropriate companies - for 2015, we would highlight the need for prospective investors to carry out their own due diligence to ensure that such investments are suitable for their own circumstances and appetite for risk-reward. 

HomesHouse builders Bovis Homes and Telford Homes are beneficiaries of an expectation that UK interest rates are set to continue at historically low levels throughout most, if not all, of 2015. While overnight money (Bank, often termed Base, rate) is likely to remain at 0.5% until the final quarter of 2015, a more meaningful forward-looking indicator is that a 5 year fixed mortgage (with a 35% deposit) currently costs 2.39%. Beyond affordability, aided by the Chancellor's recent reduction in stamp duty for homes valued below £933,000, the other prime supportive factor for the domestic housing market is the job market and we anticipate that unemployment is set to fall (from 6.4% of the labour force to 5.7%) in 2015. Although the house building sector has comfortably outperformed the wider market over the past 3 years, and is more homogeneous than most industries, equity valuations have struggled to keep pace with the magnitude of consistent upward revisions to profits. Historically, the sector performs well in the first quarter of the year and investors will wonder if this can occur again ahead of the political uncertainty posed by a general election. 

Bovis Homes (BVS)For calendar 2015, the south of England (excluding London) focused Bovis is forecast (based on a consensus of 11 analysts) to deliver earnings per share (EPS) of 101.8p - an increase of 30.5% on 2014 - putting the stock on a price-to-earnings (PE) multiple of 8.7 times, a 30% discount to the wider market's PE ratio. Besides its above mentioned geographic focus and product offering (think family house for a London commuter), Bovis is regarded as possessing excellent management with a focus on maintaining high returns on capital employed (currently 16% and targeting 20% by 2016 via a business featuring higher operating margins, 15.9% in H1 2014, than the industry average) and low financial gearing (debt of £45.3m as at 30 June 2014, compared to current equity worth of £1,172m). Going forward, management expect to increase volumes (to 5,000-6,000 units per annum, from its land bank of 17,700 plots with planning consent) and prices (from current £212,500 via product mix, rather than overall market inflation) to achieve operating margins of 18% and materially increase the dividend pay-out ratio (forecast yield of 4% for 2014). Current Sell side (broker, rather than fund manager or owner) opinion on this FTSE250 index constituent is universally positive; 11 Buy recommendations, featuring a typical price target of £10. 

Telford Homes (TEF)By contrast, Telford Homes is listed on the Alternative Investment Market (AIM, which possesses lower standards of corporate governance or disclosure and is less strictly governed) and with a market capitalisation of £210m is less than one fifth of the size of Bovis. Characterised by a focus on east and north London, with strong relationships with the capital's local authorities (one-third of homes built are affordable housing, built at much lower margin, but representing only one sixth of group revenue),Telford Homes' proposition is a £400,000 (as at 31 March 2014, up from £353,000 a year previously) apartment. Unlike national builders, Telford have yet to report a mortgage facilitated via the government's Help to Buy scheme and in the last published accounts (year ended March 2014) its customer base was 35% UK owner occupiers, 33% UK Buy-to-Let and 32% overseas investors. Return on Capital employed (ROCE) and operating margins are comparable to its larger peer and, while broker research is very limited, the shares' valuation appears to be similarly undemanding: in the year to 31 March 2016, Telford Homes are expected to produce EPS of 40p (an increase of 31% on the current year) to put them on a PE ratio of 8.7x. A similar hike in dividend would leave the stock offering a yield of 3.8% at the current 350p price. Higher risk than Bovis, due to its geographic focus (a pure play on the London economy and housing market in the eyes of global investors) and AIM status, directors have high confidence (underpinned by owning 12% of the firm) expecting profits to double by March 2018 and, so by earning a cumulative £120m profit in those four years. The company's low valuation means that it is likely to feature in any industry consolidation. 

Oil PriceThe dramatic fall in the oil price represents a real concern for the industry (especially upstream explorers), but its impact on consumers - both corporate, especially manufacturers & transportation businesses, and personal - is undoubtedly positive, reducing operating costs and boosting cash flow. Both fundamental and technical assessments of the current situation (noting the magnitude of the fall: a near halving, from US$110 per barrel) suggests that oil prices could remain low in the short term - to put a major dent in inflation - but will probably recover some of its value later in the year. Endeavouring to capture those expectations, investors may wish to consider airlines (who, as major fuel consumers, typically hedge this major cost by buying forward supplies) as obvious beneficiaries and oil companies as prospective candidates for recovery. 

Flybe (FLYB)International Consolidated Airlines Group (or IAG, owner of British Airways & Iberia), easyJet andFlybe are airlines of varying size and possess different business objectives, but share a dependence on the price of aviation fuel. Therefore, their respective share price performances since the oil collapse (the middle of October) may surprise: IAG up 50%, easyJet up 25% and Flybe down 10%. Despite a mixed history, the management of airlines are showing themselves to be capable of addressing complex dynamics (or working parts), difficult strategic issues and becoming more shareholder-friendly. Over the last 2 years, investors in IAG have had their patience rewarded as the benefits of the Iberia & BA merger finally emerged. In similar vein, and notwithstanding a turbulent 2014, shareholders of easyJet have seen an upward re-rating of their stock over the past 3 years. Both companies are well supported by institutional investors and offer further upside (especially if the oil price remains 'lower for longer'), but the much smaller and higher risk-reward FTSE Small Cap index constituent Flybe has yet to excite the wider investment community. Midway through a 3 year corporate 'turnaround', new management has taken costs out of its business (30% headcount reduction, changed routes), strengthened a weak balance sheet (£150m raised) and transformed its fleet of aircraft as it seeks to focus on regional airports (including new bases like London City) and new routes. Don't expect too much in the current trading year, but a dramatic improvement should become evident in the year to 31 March 2016 when EPS of 12.4p is forecast - which would put this £235m business on a PE multiple of 8.8x, with a small dividend possible. 

Petrofac (PFC)Turning to FTSE100 index constituents which slumped in response to the lower oil price, exploration companies like Tullow Oil fell 35% and provider of services to the natural resource sector Petrofacfell 30% in the final quarter of 2014 (retreating by 50% and 40% respectively over 2014 as a whole, testing new 5 year lows). Tempting though it is to buy something that has fallen a long way, per se, it is necessary to reassess the new fundamentals and a djusted stock valuation before being satisfied that an investor is procuring a genuine bargain rather than catching the proverbial 'falling knife'. While the equity value of Tullow will probably pick up upon any recovery in the oil price, the location of its oil fields prompts caution for this investor. By contrast, the shares of 'shovels & picks' supplier Petrofacpossess more obvious valuation appeal: based on a consensus of 21 brokers, EPS of 105.2p is forecast for the year just ended, implying a PE ratio of 6.8x, with a dividend pay-out of 40.4p offering an income yield of 5.6%. The company's guidance on future profits has persuaded analysts to pencil in a lower EPS of 98.6p for 2015, but with a small increase in the dividend, which is almost 2.5 times by earnings for that year. No rush to buy if oil stays depressed, but the writer agrees with the Sell side recommendations (which are universally positive: 7 say Buy, 14 Hold) and Petrofac stock should recover along with the oil price over the medium term. 

Ithaca Energy (IAE)For growth minded, higher risk-reward investors seeking a more geared play on the possibility of a recovery in the oil price, Ithaca Energy is worth a closer look. AIM listed, the shares of this North Sea oil and gas producer have fallen by 43% over the past 3 months. In particular the market has worried about a US$75 per barrel hurdle and a potential peak borrowing position of US$600m that applies to the development of its Stella oil field in mid-2015. The £210m equity capitalised company has grown via acquisition (notably of Valiant in 2013) to currently possess assets boasting production of 25,000 barrels of oil per day (with 58m net proven & probable reserves), and 12 analysts (11 of which recommend a Buy, and 1 suggests Hold) suggest EPS of 4.67p in 2014 and 11.7p in 2015 equating to a PE of 13.7 falling to 5.5x. Well monitored, the forecast for earnings in 2015 have come down - along with the oil price - from 23.3p six months ago, to 21.5p in October, and 18.5p just a month ago. This financially and operationally geared play on oil prices (albeit on the high cost of extraction, but low geo-political risk of, North Sea assets) is also favoured by US$1bn of UK tax allowances. 

In conclusion I would summarise by saying that a combination of 'top down' macro thematic industry sector calls and 'bottom up' company stock specific has flagged up Bovis Homes (BVS) andPetrofac (PFC), with the addition of smaller companies Telford Homes (TEF), Flybe (FLYB) andIthaca Energy (IAE). 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.