Following another week of drama, a seasonal message

Friday, 23rd December 2016 10:41 - by David Harbage

It has been another week of dramatic news headlines – dominated by terrorist and military atrocities in Germany, Iraq, Turkey, the Yemen and, inevitably, Syria.  By contrast, hard headed investors may have taken little account of such tragic geo-political events as stock markets continued their progress to near-record highs.

Approaching the season of hope and light, it would be good if 2017 could mark a change for the better: that our differences and human disputes could be resolved by conversation rather than conflict. The prospect of a resultant ‘peace dividend’ – as governments spend less on armaments, and reinvest into health, education, shelter, food and water – would represent a real reason for cheer. Not just on moral grounds, but also by reference to economic impact. Invariably it would seem, the poorest in the world suffer most from political instability and tribal warfare.

Almost a year ago today, this blogger wrote a piece entitled ‘Investing with good intent’ – commenting on recent developments at Sports Direct in particular, but discussing whether behaviour or reputation matter in the world of business. For the record, the ex-FTSE100 retailer of sporting goods struggled to convince fund managers that it had changed for the better and the shares fell from £6+ in December 2015 to 276p today. The merit and shortcomings surrounding so-called ‘ethical’ investment can be debated, but the application of conscience in making investment decisions seems to be growing pace. Charities will naturally be mindful of any conflict between their objectives and underlying assets (for instance a cancer research or treatment organisation would be expected to exclude tobacco manufacturers), but increasingly other investing institutions and private individuals will seek to focus on companies which match their beliefs, as well as aspirations.

In a dangerous and often dysfunctional world, investors can seek to both capture the potential beneficiaries as well as support businesses which endeavour to address the problems. As an example, G4S represents one of the world’s largest security firms: employing 340,000 people in 100 countries, demand for its services (which range from electronic surveillance systems to manned guarding to cash transit) is intuitively co-related to crime and terrorist threats. The company has a somewhat chequered history – as one might expect from such a large employer carrying out high profile tasks (such as guarding in prisons or airports) – but over the past six months consensual broker opinion has turned positive, and earnings growth of 6% this year is expected to accelerate to 15% in 2017. G4S shares appear somewhat undervalued by comparison with the wider UK equity market, when looking at what analysts predict for next year; by reference to profits, the stock stands at a 10% discount to the FTSE250 index and a 4.1% dividend yield is covered 1.75 times by forecast earnings. In the absence of a more obvious peace keeping force, this stock may have appeal in searching for a company who could thrive in today’s dangerous environ.

Looking for listed businesses that make a more positive contribution to the world’s population - by countering some of its most obvious problems - is a wide ranging and more difficult task. However, manufacturers of medicine and other health-related businesses stand out as obvious forces for good and, in the remainder of this article, will comment on just a few which could improve the quality of life for many in 2017.

FTSE100 giant GlaxoSmithKline produces a wider range of mainstream drugs used to treat a wide range of acute and chronic conditions. Its equity worth is £76bn and, being unchanged over the last five years, this business has been likened to an ocean going vessel which struggles to make significant progress in rough seas – as older core medicines within its portfolio go off patent (losing high margins as generic competitors emerge) and finding new ‘wonder’ drugs to replace those earnings is difficult. However, investors focused on dividend income have received a good return on their investment; the shares currently yield 5.2%. Although a high proportion of profits are used to pay this distribution (dividend cover: that is comparing earnings to dividend, is negligible), the prognosis for earnings in 2016 and next year is improving. There is evidence that the analytical community has been warming to ‘big pharma’ as a sector of industry, and to GlaxoSmithKline in particular – of 26 UK-based brokers, who monitor the company’s progress, 13 suggest a Buy and 12 a Hold, leaving just one negative opinion. Being a major US dollar (and non-£) earner, the company has also received profit upgrades post Brexit and a boost to its popularity amongst investors.

Looking beyond those dividend attractions, three other health-related companies - of varying size and specialism - deserve a mention because of their growth potential. Each has merit in terms of its recent history and current organic growth, but also sector watchers will be aware that these businesses will be attractive to prospective predators. Shire is one of the world’s leading biotechnology firms with a focus on discovering treatments for rare diseases and highly specialised conditions; these include haematology, immunology, and neuroscience, gastrointestinal and ophthalmic. Perhaps not well-known, but this is a big business, having a market capitalisation of £41bn and set to produce profits in excess of £3bn this year. However, management focus is on growth (reinvesting profits into R & D, research & development) and so pays a miserly dividend worth 0.5%. The company has a strong following both on the ‘Sell’ side – with 25 research houses issuing positive notes on the stock – and amongst institutional fund managers (Blackrock own a 7% stake worth £2.8bn stake and Fidelity a disclosable 3%+ worth £1.3bn).

Unlike Shire who fought off a bid approach (from AbbVie two years ago), joint replacement industry leader Smith & Nephew have yet to face a hostile takeover attempt – although both its orthopaedic peer Stryker and pharmaceutical giant Johnson & Johnson are presumed to have come close in the summer of 2015. While the underlying business is much less racy than its larger FTSE100 peer, Smith & Nephew nevertheless possesses a £10bn equity valuation; having seen its share price double over the past five years. Profit growth projections appear quite pedestrian for 2016, but are expected to pick up in 2017 when an advance of 9% in EPS is forecast. Yielding 2%, covered almost 3 times, and again enjoying unanimous support from the broking community, this stock is also principally about growth rather than an immediate income pay-out.

The final health related company worth a closer look is the much smaller, AIM listed, pharmaceutical and services group Clinigen, which specialises in the management and supply of both unlicensed and clinical trial medicines. The company came to the stock market in September 2012 and has enjoyed strong demand for its market leading clinical trial area, together with growth in its portfolio of (typically hospital-only) drugs. The shares of Burton-based Clinigen have risen from 200p to 720p and to a market worth of £828m, which has attracted attention from several smaller company fund managers (including Axa, Old Mutual and Cazenove). Looking forward to the year to 30 June 2017, profits are estimated to rise 17% - which accords with a FY1 price earnings ratio of 17 times (that is delivering a PEG ratio of 1.0). However, with the emphasis on ploughing cash back into the business, often via acquisitions, dividend income is a low priority and the shares offer a yield of just 0.6%. Five brokers publicise their positive recommendations on the business; most recently Numis who indicate 30% upside by placing a 933p price target on the stock.