UK PLC - overseas buyers think we're cheap

Tuesday, 20th August 2019 07:10 - by David Harbage

Yesterday afternoon’s announcement that one of the UK’s biggest pub operators, Greene King, had received and recommended acceptance of an 850p cash offer should come as little surprise to investors. The offer, from the Hong Kong listed property group CK Asset Holdings, is one of many overseas purchases of domestic businesses in 2019 to date – which, being priced in sterling, will often be perceived by predators as being underpriced, if not cheap.  

Bury St Edmunds-based Greene King, founded 220 years ago and today employing more than 38,000 people operates 2,730 pubs restaurants and hotels across Britain – under its Chef & Brewer, Farmhouse Inns, Hungry Horse, as well as its own brand, local pub label. While not as significant in revenue or profit terms, the company is equally well known for its ale brewed at Bury St Edmunds and Dunbar: Abbot Ale, Bellhaven Best, Greene King IPA and Old Speckled Hen.

Nick MacKenzie has only been CEO since 1 May, and in his short tenure had announced trading results on 27 June covering the year to 28 April 2019. Despite the numbers being slightly ahead of City analysts’ expectations, featuring operating profit margins of 15% and gains in market share, Greene King shares have continued to drift downwards. Cited in this blog on occasion as a classic example of how institutional investors were neglecting domestic company shares since the EU referendum vote, the stock had fallen from 893p in June 2016 to close 2018 at 528p – by contrast with the overall UK equity market, which had made good progress.   

This is a £2.6bn market capitalised FTSE250 constituent is profitable and, with 81% of its estate being freehold or owned on long leasehold, the company features significant asset value. This was highlighted within the final results’ mention of the refinancing of the debt acquired as part of the recently purchased Spirit group: an estate revaluation indicated a market value of £4.5bn, versus the book value of £3.5bn. Re-engineering its balance sheet had reduced the cost of debt – and historically low rates means that acquirers will not be put off highly geared businesses if well covered in asset backing terms and net debt is falling. Strong cash generation delivered a £89m reduction in net debt to £1,943m in the last accounting year.

Greene King is a well-established business (earnings per share grew 2.9% last year) and, with its 33.2p per share annual dividend pay-out being almost twice covered by profits, shareholders were receiving an income yield of 6% before today’s 51% jump in the share price. By contrast with the returns available on cash and government bonds, UK equity – and especially businesses with a focus or dependence on the domestic economy – appear to offer an attractive return. Of course, the major uncertainty which is Brexit could yet cause a recession in the UK, leading to a downturn in corporate profits and putting pressure on firms’ dividend paying capacity.

However, there has been no shortage of overseas buyers of UK plc – who, based on their appetite to buy British assets (from stock market listed companies to commercial property), clearly do not share the negative perspective espoused by many global investors or the general media. Buying equity should always be viewed as a long term purchase, but many (astute, in the opinion of the writer) trade buyers and investing institutions would seem to have decided that the fall in the relative value of sterling (especially pronounced for US dollar-based predators) makes this an opportune time to acquire a piece of UK plc. The level of both attempted and completed take-overs of UK-focused companies in the first half of this year is running at twice that seen in 2018 – and appears set to continue in the foreseeable future.

How can personal investors best take advantage of this trend, which could of course reverse should the pound strengthen (most likely to occur on any reversal in Brexit)? Perhaps another pub or brewery – like Midlands-based Marstons – might be on another corporate’s ‘shopping list’ Rather than try to identify and select the industry segments or individual beneficiaries – something which might prove to be exceptionally difficult (as ‘beauty can be in the eye of the beholder’ and buyers will have various reasons for wanting to purchase a particular asset) – the author would suggest looking at appropriate collective investments. In particular those which focus on UK smaller and medium sized companies, rather than the larger companies which inevitably feature the multinationals which dominate the FTSE100 index, would seem to make intuitive sense. 

The Numis Smaller Companies (excluding investment trusts) index features the bottom 10% of companies with a full (not an AIM, it should be noted) listing on the London Stock exchange. As at 31 December 2018, there were 359 constituent companies – the largest of which had a market value of £1.3bn – with a total market worth of £140bn. Within this universe, professional investors can assess the businesses with a bias towards Value and those offering more Growth – by reference to their business model, industry, track record and prospects – and, as one might expect, the more domestic, often consumer-facing companies typically fitted into the Value category with greater exposure to the UK, rather than the global economy.

Aberforth Smaller Companies investment trust is a £1bn closed-ended portfolio, benchmarked to the Numis index, but with an avowed focus on Value – in terms of balance sheet and earnings. In the managers’ half year report covering the first half of 2019, the underperformance of Value (versus Growth) within its universe of potential investee companies is discussed – and, it is suggested, such companies have never been so unloved in the Numis index’s 64 year history. To this observer, this rings true (when considering the market’s pricing of business sectors like house builders, retailers, real estate) and the long term opportunity to buy such stocks is enhanced by being able to acquire such supposedly undervalued assets at an attractive discount to the company’s net asset value (NAV). In Aberforth’s case, the discount is 13.7% (based on share price of 1125p and NAV 1304p) – which is higher than the median ‘norm’ of the past year and is in excess of its peer group.

For investors looking for an exposure to UK smaller companies, but with a less conspicuous bias towards undervalued stocks, the Henderson Smaller Companies investment trust (which also seeks to beat the Numis index benchmark) may have appeal. Boasting a better performance track record than Aberforth, because of its more balanced investment style or strategy (although owning an investment is all about prospective returns), this £570m capitalised trust is currently priced on a 10% discount to NAV. Where medium sized, rather than the smallest, companies are preferred – perhaps because a portfolio consisting primarily of better known constituents of the FTSE250 index may be perceived to be safer – then the Mercantile investment trust or its smaller sister JP Morgan Mid Cap investment trust suggest themselves, on similar 10% or more discounts to their respective NAVs.     

Readers and prospective investors should always carry out their own research into the strategy adopted by the various managers of collective funds – reading the factsheets and reports to gain comfort or otherwise in their approach to investing. Don’t be surprised to read more about corporate activity, in the form of higher takeover activity, in such portfolio commentaries – with domestic companies to the fore.

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.