Monitoring our 'Winners' performance in December 2015

Thursday, 7th January 2016 11:42 - by David Harbage

As promised, this regular article seeks to follow the fortunes of the company stocks mentioned in our blog of 30 October 2015, ‘Identify, and run with your winners’. The attached schedule shows how each share performed in December – a roller coaster month for the UK equity market, which fell 9% in the first two weeks before clawing back 5% of that drop to end 4% lower.

See how they performed in the table below >>>

So much for a ‘Santa rally’! Beyond the figures, we will comment on the outliers of December’s returns – those that performed relatively well or were particularly disappointing – notwithstanding an appreciation that these selections were made with the longer term (that is, of many years, rather than months) in mind.

House builders often seem to buck the wider stock market’s performance, be it on a daily or longer term basis. In calendar 2015, the sector’s FTSE350 constituents delivered stellar double-digit returns (by contrast with the 4% fall in that index over 2015) and, as in November, the final month of the year brought equity-contrarian returns. On the 4 December, Berkeley Group reported a positive half yearly trading report – featuring 10% growth in adjusted pre-tax profits – and an ever stronger balance sheet, featuring net cash of £263 million. This prompted the board to progress its strategy of cash pay-outs to shareholders, of what amounts to supernormal earnings, announcing plans to pay £2 per share for each of the next 6 years. Such confidence is borne out of their reading of the outlook for higher value end (London-biased) house building; this clearly extends a long way beyond the current land bank (of 38,233 plots), forward sales (of £3.1 billion) and 2015’s continued investment (in 6 major sites acquired). Pertinent comments from Chairman Tony Pidgeley on the wider residential property market – described as seeing good levels of demand in a stable operating environment - included reference to bottlenecks within local councils’ planning departments and the unintended consequences of the recent changes in property taxation.

Berkeley Group outperformed the FTSE100 by 15% in December and yet, even having reached an all-time high of 3757p on 16 December, the valuation of its equity is not demanding by reference to the wider market (by reference to its earnings multiple, dividend yield and cover all boasting relative attraction) or indeed its history (when builders have been much closer to reflecting the market-wide price to earnings ratio). Moreover, with most investor concerns for 2016 appearing to come from overseas – notably the perceived slowdown in China (and, almost as pertinently, a shortfall in the standard of clarity and corporate governance in the world’s second largest economy) and increasing tension in the Middle East (where, most recently, Iran and Saudi Arabia have severed diplomatic ties) – the attractions of this domestic play are set to remain prominent for longer. Six years anyway, noting Berkeley’s expectations - considerably more bullish than that implied in the City’s current consensual valuation.

As regular readers will have seen, the natural resource giants Rio Tinto and Royal Dutch Shell were removed from the list of ‘winners’ – because, while both are undoubtedly leaders within their respective industries, the immediate outlook for the worth of oil, gas, industrial metals and minerals is not bright. Until greater confidence in the demand side of the (supply-demand) equation returns, prudence suggests that there is no rush to include even the industry’s blue chips in this list. Royal Dutch Shell is set to command further investor attention in January, as completion of its takeover of the BG Group nears and analysts focus on its ability to maintain its dividend. For the record, the ‘B’ shares of this integrated (incorporates both upstream exploration and downstream refining & marketing activities) Anglo-Dutch energy business fell 8% in December, while Rio Tinto shares retreated 10%.

The stock of fashion retailer Next came under pressure in December, as expectations of price cutting arising ever earlier in the clothing trade are proving correct and the highly competitive nature of this industry is confirmed. Ahead of pessimistic predictions for the Christmas period and the end of year Sales, the share price ended the month 9% lower. A trading statement from the company on 5 January confirmed these fears, as overall like-for-like (excluding new stores/space) revenue in the final quarter of the year was lower and only the online Next Directory recorded growth (of 2.0% in the 2 months to 24 December 2015). However, this represented a marked slowdown from the 6.1% growth which this online proposition achieved over 2015 as a whole – in part due to poor stock availability. Exceptionally warm weather in November & December inhibited group sales, but management maintained discipline in maintaining profit margins (principally by not discounting stock until their End of Season Sale).

Short term sentiment is likely to remain weak, given the sales disappointment (below the 4-6% growth turnover target for 2015), but good cost and stock management has enabled this well-regarded Board to reassure that profit forecasts remain unchanged – which were slightly raised in its October 2015 update. Such regular guidance has been a positive feature of Next and, alongside its successful Directory, has been a differentiating factor within an industry best known for profit warnings and bankruptcy. The very nature of fashion clothing means that it is a particularly difficult product to successfully retail. In calendar 2016, management predict sales and profit growth of between 1-6% which, incidentally, would maintain a pace comfortably ahead of its peer Marks & Spencer. Like Berkeley Group, Next have established a policy of returning surplus cash to shareholders in the form of special dividends; 230p was paid out in that way in 2015, and a further 60p payment will be distributed on 1 February 2016. This could yet be enhanced via share buybacks, which can be executed when the stock price falls below £69.62 (further evidence of disciplined financial management, applying an 8% rate of return to its forecast profit), a level last seen in January 2015.

Elsewhere, in the month of December, the shares of Smith & Nephew represented a ‘stand out’ feature: outperforming the wider UK equity market by 10%. This business has been a perennial favourite of commentators seeking to identify takeover targets - with a couple of US suitors presumed to be poised to buy this company’s intellectual property in orthopaedics – but this most recent rise can probably be justified by more down-to-earth fundamental reasons. Brokers’ earnings upgrades (historically the prime driver of the worth of equity capital) have been seen, most recently from UBS whose research team believe the shares are worth 1250p, which followed regular stock repurchases, as well as director purchases and support from the big institutions. On that ‘Buy’ side, prominent owners of Smith & Nephew include Invesco (via a 5% stake), Blackrock (5%) and Walter Scott (4.4%). Like Next, the stock is not cheap –standing at a significant premium rating to the wider market – but demographic drivers (notably the increasing number of older people in relatively rich nations) make healthcare a core industry for any diversified portfolio.     

Written by David Harbage for lse.co.uk on the 6th January 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.