Recent excitement in the market.

Tuesday, 16th May 2017 08:00 - by David Harbage

May 5 – Marks & Spencer announce that Mr Archie Norman is to become their chairman, with effect from September 1 2017. Best known for making Asda a retail powerhouse in the 1990s (second only to Tesco in domestic food market share), he was CEO and chairman before selling Associated Dairies to Wal Mart in July 1999. The ‘marmite’ retailer continues to put its future focus on food (switching floor space, via store closures and opening new food-only outlets); something fund managers had been telling the group to do for decades, and M&S are likely to accelerate the pace of this strategic transition.

Whether the new management (49 year old Steve Rowe became CEO a year ago, and announced on May 3^rd that the CEO of Halfords, Jill McDonald, is to head up non-Food) can reverse the negative sentiment towards the business remains to be seen. Exactly two years ago, the M&S share price was 594p and its subsequent fall has mirrored the 20% retreat in the group’s pre-tax profits over the period. After reaching a nadir of 285p in June last year, the stock has enjoyed a rally since the spring and now appears fully valued given that earnings are unlikely to show any significant rally before the year to March 2020. On a prospective price-to-earnings multiple (PE ratio) of 13 times, much is already expected from a management team which has significant demographic headwinds (not least from online competition) to battle. Although the current dividend yield of 5% offers some support, more attractive investment opportunities probably exist elsewhere. Of 24 pieces of different broker research, only 7 concluded that Marks & Spencer shares represented a Buy.

May 10 – Barratt Developments pleased the City with its trading update covering 2017 to date, indicating that pre-tax profits for the year to 30 June 2017 would be at the top end of analysts’ forecasts (£733m). Business remains brisk (0.8 reservations per week), with forward sales up 12.7% to £3.2bn and –come 30 June - management expect to have delivered 17,350 completions and £600m net cash. Acquiring new land at prices that enable the group to hit its profitability targets, of 20% gross margin and a 25% return on capital employed (known as ROCE), plots representing 17,000 units are expected to be added to the land bank.

The group’s operational processes are industry leading and, in March this year, Barratt extended its possession of the Home Builder Federation’s 5 star customer satisfaction award to 8 years. A strong report: there was no mention of higher build costs, but rather a suggestion that average selling prices were advancing. Post the update, a number of brokers upgraded their numbers to come into line with CEO David Thomas’ projections, with Numis and UBS placing price targets of 656p and 625p respectively on the shares. On the ‘buy side’, fund managers Capital, Blackrock, Standard Life, Ruffer, Polaris Capital and Fidelity own stakes of between 3% and 9% in this FTSE100 index constituent. JP Morgan isn’t far behind with a £105m holding and, most recently, value-focused Neil Woodford has invested £70m of his Woodford Equity Income fund into the builder. A consensus of 14 brokers (which includes 2 negative recommendations) anticipate 58.1p of earnings per share (EPS) in the year to June 2018, putting the shares on an undemanding PE multiple of 10.4times.  Barratt Developments typically pay out two thirds of their earnings in the form of dividend and, while in current cash return mode of ‘distribute supra-normal profit’, the shares yield 6.7%.   

May 12 - Astra Zeneca, the UK’s second largest pharmaceutical company announced Phase 3 positive results for its highly promising lung cancer medicine, called Imfinzi. Few investors can recall global blockbuster (the likes of Glaxo’s anti-ulcer treatment Zantac) drugs, as it has become increasingly difficult to find genuine treatments for humankind’s prime diseases. However Astra Zeneca did possess one, in the shape of cholesterol-lowering tablet Crestor, which has now gone off patent (and so cannot command its premium price, as generic forms are produced by other pharmaceutical manufacturers). Lung cancer claims more lives than any other (more than breast, prostate and colon-rectal cancers combined) and it is hoped Imfinzi can be successful where chemotherapy has not. Essentially the drug encourages the body’s immune cells to kill the cancer and represents an alternative to radiation or chemotherapy treatments.

Industry analysts have put the value of the potential lung cancer market at between US$1.75bn-3.5bn, but the treatment could also be efficacious in treating other forms of cancer. AstraZeneca has long been regarded as possessing an excellent research and development (R&D) facility and offering an attractive potential portfolio of new medicines - which had been the attraction for American pharmaceutical group Pfizer’s US$69.4bn take-over attempt in May 2015. Intuitively, the fast-increasing ageing global population means that health businesses should enjoy strong demand and profit growth.

The previously mentioned lack of success in finding new drugs has, however, meant that the UK’s two largest pharmaceutical companies have been seen as a source of dividend income - rather than profit growth - over the past twenty years or so. AstraZeneca‘s shares currently offer a reasonable level of income at just over 4%, but earnings growth over the next two years is like to be pedestrian at best. On a PE of 16.8 times (a 20% premium to the wider market) after last week’s Imfinzi boost, the stock may mark time until further evidence of regulatory approval emerges. Although the protracted nature of getting a new drug to market means that earnings upgrades cannot be expected to result from this latest ‘discovery’, it should entrench the positive views generally expressed by the ‘Sell side’ industry: 20 brokers say Buy, 13 say Hold and 5 pronounce a  Sell.

May 14 – the ransomware, so-called ‘Cyber-attack – known as WannaCry - on the computer networks of major public (including the UK’s National Health Service) and private institutions has impacted thousands of agencies in more than 150 countries. Such sabotage or ‘hacking’ has been predicted for some time, but governments and corporations will now redouble their efforts to strengthen firewalls and find new solutions. Against a backdrop of unlimited downside cost for corporate security breaches, upwards of a US$1trillion spend over the next four years has been forecast by industry experts (Cybersecurity Ventures report in February 2017, admittedly ‘talking their own book’). Investors seeking to own the beneficiaries of such defensive, ‘firefighting’  activity may struggle to identify obvious UK listed company stocks, as often larger firms may possess relatively insignificant (compared to their overall business) security offerings - such as British Aerospace) – or be very small, barely profitable enterprises.

However, Oxford-based, Sophos Group which provides endpoint, mobile, server, encryption, web, e-mail, Wi-Fi and firewall solutions - to 100m users in 150 countries, via 26,000 registered partners - looks set to maintain its strong track record in the foreseeable future. On 4 April, management of this FTSE250 index constituent advised that billings growth in its fourth quarter to 31 March 2017 were up 27% - accelerating from its 2016 pace of 20% - and, as a consequence, profits were set to exceed consensual forecasts. Those have now been updated to anticipate earnings per share (EPS) of 7.17p for the year to March 2019, which equates to the stock being valued on a heady PE rating of 47 times. Since its 1 July 2015 listing on the London Stock Exchange, investors in Sophos have had a bumpy ride, but sentiment now appears to have ‘turned the corner’ with 8 brokers publishing a Buy recommendation and only 1 proffering a Hold. This is not a small company, having a market capitalisation of almost £1.7bn, but is already priced with high expectations of growth and little income (yields just 0.4%) for ‘widows or orphans’.

Lower risk equity investors may wish to investigate an industry-specific collective or pooled investment. In particular, an exchange traded fund (ETF) which, since launch on 1 September 2015, seeks to match the International Securities Exchange (ISE) Cyber Security UCITS index of public companies, possessing a market capitalisation in excess of US$100m, which are actively involved in providing infrastructure or services, hardware or software for cyber-based security.

As at 28 April 2017, the ISE Cyber Security ETF managed by ETF Securities - ticker for the £ units is ISPY (!) – was invested as follows:

By product: software 52%, communications equipment 17%, information technology (IT) hardware 12%, IT services 8%, Aerospace & defence 3%, internet software & services 3%, telecommunications 3% and defence 2%. By country: United States 67%, Israel 12%, Japan 8%, South Korea 5%, United Kingdom 4%, Netherlands 2% and Sweden 2%. By company size: large capitalisation stocks 22%, mid cap 32% and small cap 46%. The current top 10 holdings is led by the sole British firm Sophos 4.4%, followed by Imperva 3.7%, Juniper Networks 3.7%, Cyberark Software 3.5%, Splunk 3.5%, Symantec 3.5%, Akamai Technologies 3.5%, Fortinet 3.4%, Proofpoint 3.4% and Qualys 3.4%.

The above mentioned benchmark index has delivered returns of 53.5% and 77.1% over the past 3 & 5 years respectively to 31 April 2017, outperforming the overall US equity market by 7% and 3% respectively. Domiciled in Ireland and qualifying as an ISA investment, this ETF’s total expense ratio (TER) is relatively high, at 0.75% per annum, reflecting its specialism.   

Have a good week, with more excitement in the market to come…

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.