Monitoring our 'Winners' performance in April 2016

Tuesday, 3rd May 2016 10:00 - by David Harbage

April, famed for its blustery showers and unpredictable weather, brought a few surprises to stock market watchers. UK equity ended the month 1% higher, largely attributable to a 21% recovery in the price of oil in April (Brent crude reached a 2016 high of US$48.1 on Friday) and a rally in the blue chip mining stocks in response to production cuts across the industry.

Looking beyond commodities, investor sentiment has been fragile as a number of leading global strategists have lowered their expectations for economic growth for this year and next. In the United States the stage is set for a polarising and eventful political election, as the front runners for nomination as their party’s presidential candidates (Mrs Hilary Clinton for the Democrats and Mr Donald Trump for the Republicans) reinforce their respective leadership positions. Domestically, the focus on Brexit, notably debate surrounding the potential consequences of Britain leaving the European Union, has contributed to a lack of appetite for sterling priced assets.       

More of the same can be expected in May, although the prospect of further immediate progress in the oil price is not encouraging. Production indiscipline within OPEC’s ranks is offsetting reduced US supply; Saudi Arabia, Iraq and Russia are set to release more oil over coming weeks. Mixed messages, notably from forward-looking survey data, surround economic activity in China and the Eurozone point to a stagnating landscape. Against such an uninspiring backdrop, analysts have been trimming top line revenue forecasts and their expectations for bottom line profits. The need to be discriminating – and assess the quality, or reliability, of earnings – comes to the fore as seen by the resilience of demand (both from the customer for its non-cyclical products and investors for the equity) of businesses such as Imperial Brands, Reckitt Benckiser and Unilever. By contrast with slippage from the wider market, each of these companies saw brokers upgrade their forecasts for 2017 profits. Beyond tobacco, cleaning and food products, positive earnings revisions over the past month have also been seen at healthcare firm Smith & Nephew, as well as at the economically sensitive property company Workspace and media giant WPP Group.  

The subject of board directors’ remuneration has been a recent controversial feature, across the wider media, with Sir Martin Sorrell’s near £63m package as CEO of WPP attracting almost as much attention as the CEO of BP, Sir Bob Dudley. However, with stock option-related reward being the overwhelming portion of such executive pay (Sorrell’s salary is circa £1.1m), a clear differentiation exists in terms of rewarding success. The harder call is determining the extent to which wealth creators should share in that success. As publically quoted and owned companies, shareholders have the right and responsibility to decide on such matters; recent protests at proposed awards – notably at CRH, HSBC, Shire Pharmaceuticals, Smith & Nephew and Weir Group - appear set to continue this Thursday when investors at Reckitt Benckiser will vote on its pay report and remuneration policy. The headline writer’s focus will be on CEO Rakesh Kapoor’s pay package, which almost doubled to £23m last year. Like Martin Sorrell, who founded WPP in 1986 and whose near 1.5% stake in the group is currently worth £302.5m, Mr Kapoor is also a longstanding employee of RB (having worked for the household product firm for almost 30 years) and is a major beneficiary of its ongoing success via a shareholding worth £31.6m.   

After a busy February and March when most of the portfolio’s constituents announced trading results, April was rather quiet in terms of company announcements or other news flow. Capita announced an extended contract with Debenhams, worth £72m, where it facilitates much of the retailer’s online offering. Despite strike action in France prompting 611 cancelled flights in March, easyJet reported a 4.3% increase in passengers carried that month – compared to a year ago – while in the year to March 2016 passenger numbers increased 7.2% to 70.7m. In its AGM statement on 22 April, HSBC confirmed that its legal domicile and headquarters are to remain in the UK but, should Britain vote to leave the EU, it may decide to move some of its wholesale operations from London to Paris. The chairman, Mr Douglas Flint, talked about how the bank was adapting and reforming itself in response to the challenging economic and regulatory environment (highlighting the so-called Panama Papers) as well as citing recent successes in China – notably in taking advantage of trading in foreign exchange and local securities, as well as developing its presence in the technology-rich Pearl River Delta business area. Banks are significantly undervalued by reference to a share price to book value metric (HSBC and global peers are on an average discount of 25%, other UK listed banks on almost 50%) relative to the past forty years, but this is not surprising given the raft of headwinds facing the industry post the 2008 crisis. The board’s commitment to a progressive dividend provides comfort and should support the equity valuation until the economic prospects improve (and bring higher interest rates and profit margins).

Elsewhere, Reckitt Benckiser pleased a demanding City, with its first quarter results on 18 April showing 5% growth in like-for-like revenue accompanied by a statement indicating that the group was on track to meet its full year targets. The latter includes moderate margin expansion; its health division (featuring Durex, Gaviscon, Scholl and Strepsils), which accounts for 34% of turnover, was the stand-out performer via 10% growth in sales. By contrast, the quarterly results from Sky on 21 April fell short of consensus expectations, despite a 5% advance in group turnover and 12% hike in operating profit for the nine months to 31 March 2016. While the shares retreated 8.3%, the analysts’ research seen since the trading update have not included any reduction in earnings forecasts for 2017 and all have reiterated positive recommendations. Earlier in the month, Unilever had matched broker estimates of their first quarter results – which saw underlying sales growth of 4.7% across the group (delivered through a mix of volume growth of 2.6% and a 2% uplift in pricing) and a jump of 8.3% in its emerging markets. Management spoke of a fragile consumer in its more mature markets of Europe (especially) and the US but, with all four business activity divisions making progress, the quarterly dividend was hiked 6%.

Continuing on the results ‘front’, Whitbread produced its numbers for the 53 weeks to 3 March 2016; there were no real surprises from the previous trading statement’s intimation, with like-for-like sales growth becoming harder to achieve (up 3%, EPS +5.3% and dividend +10%). New CEO Ms Alison Brittain is committed to maintaining the pace of growth in the business (Costa coffee outlets and Premier Inns) and was upbeat about prospects, telling investors that she was “confident of making good progress this year”. On 28 April, WPP announced a trading update for the first quarter of 2016 featuring underlying revenue growth of 5.1% which, along with profits, were ahead of the company’s targets. Beyond such organic growth, 26 acquisitions were made in the quarter and clearly the management remain keen to make further bolt-on purchases of firms offering both complimentary and new business activities.  While the outlook statement was somewhat downbeat, referring to their corporate clients as being cautious, analysts were reassured by the numbers and moved their profit estimates for 2017 a smidgeon higher.    

The portfolio’s medium sized (FTSE250 index constituent) real estate companies had a better month. Unite, the provider of university accommodation, announced a 2.8% increase in the value of its prime fund (75 properties in 24 UK locations worth £2,132m) and a 1.5% increase in its joint venture fund (12 London & 3 Edinburgh properties worth £750m) during the first quarter of this year. On 27 April, the group made a significant acquisition in Liverpool - which is expected to cost £70m to develop for a September 2019 opening – and hosted a Capital Markets presentation to showcase its Coventry site. Both the sell side (brokers upgraded profit and net asset value expectations for the years to March 2017 & 2018) and the buy side (institutional investors, adding to their positions over the past few weeks) warmed to Workspace, which owns 80 properties in and around London. This comes as a contrast to Berkeley Group, which has lost ground against the backdrop of media concern that overseas appetite for residential property in London could be adversely affected by a Brexit outcome. In particular broker Credit Suisse downgraded their assessment of the upmarket builder from Neutral to Underperform, and placed a fair valuation of 2372p on the shares. For more on this subject, please read the previous 17 April blog ‘Fears of Brexit provides opportunity’.    

David Harbage  

1 May 2016

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.