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  • Five shares to watch in 2023

    We look at five shares investors could consider in 2023.

    five shares to watch in 2023

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    The HL Share Research Team

    We’re in uncertain times. It’s more important than ever to make sure you hold a diversified pot of assets – meaning you’re not overly exposed to one type of investment. For investors who can accept and manage the extra risk, that can include looking to individual shares.

    There are certain companies we think have better long-term potential than others in their sector or that are better placed to stand firm in the ongoing weak economic environment.

    Please remember investing in individual shares isn’t right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks.

    Make sure any new investment forms part of a diversified portfolio.

    This isn’t personal advice or a recommendation to buy, sell, or hold any investment. Share prices can go down as well as up and there’s always a risk you could get back less than you invest. If you’re not sure what to do, please seek advice.

    Information correct as at 1 December 2022 unless otherwise stated.

    Five shares to watch 2023 – third quarter update

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    BAE Systems

    Critical supplier in today's world

    BAE Systems manufactures, services and sells military tools and equipment, like fighter jets, aircraft carriers, and increasingly Cyber & Intelligence tools. It has annual sales of around £21.3bn, and underlying operating profit of £2.2bn.

    BAE’s enormous scale and specialised products mean there aren’t too many competitors. Its main customers are the US and UK governments, which adds a level of reliability. The group’s order backlog stood at £52.7bn at the half year mark. That gives the group visibility over demand others can only dream of. It also underpins the prospective yield of 3.9%. No dividend is ever guaranteed.


    Source: Refinitiv Eikon, correct to 14/11/22. *estimated values

    Today’s geopolitical climate means threat levels have increased. We think governments are less likely to rein in defence spending. It also means other countries are likely to move to bolster their own fleets and systems, which is a potential benefit for BAE.

    There are some risks that come from investing in a defence company. Some institutional investors exclude investments in the sector, which can cap returns. At the same time, defence companies like BAE are at a higher risk of controversial events than others. There would be downward pressure on the valuation if something like this were to occur. A broader risk is that government defence budgets tend to wax and wane, and we expect BAE’s order intakes to broadly follow these trends.

    Cash flow has historically been a thorn in BAE's side. Working capital management coupled with strong profits means this is the second year running that cashflow is in the black.

    Costs are facing pressure from supply chain disruption, but for now BAE says it's offsetting the worst of the financial impact.

    As a critical defence supplier in today’s uncertain world, we think BAE is in a strong position, and has long-term potential. Those perceived strengths do come with some extra risk though. The shares change hands for 12.6 times expected earnings, slightly above the ten-year average.

    A member of the Share Research Team holds shares in BAE Systems.

    British American Tobacco

    Cash king

    British American Tobacco, with a market cap north of £70bn, is the second largest tobacco company in the world. And with that scale comes pricing power.

    But as consumers become more health conscious, tobacco volumes are falling. Squeezing more from less is the plan, and so far that’s working. Sales at the full year are expected to top £28bn, with annual growth of just over 9%.

    One of the key benefits for a tobacco company is the low cost to make the products. A stable gross margin, hovering just below 80%, proves that point. But it’s cash flow that really pays for things, and BATS has that in abundance.


    Source: Refinitiv Eikon, correct to 16/11/22

    If we look at cash conversion, BATS has been a consistently high cash generator for years. That’s helped support a dividend that’s grown at an annualised rate of 8% over the last 10 years and £4.5bn of share buybacks over that time. No returns are guaranteed.

    Paying down the debt pile is a draw on cash. In 2017, BATS bought US-based Reynolds in a cash and stock deal worth $49.4bn. Debt’s reduced by more than £8bn since then and BATS expects the ratio of net debt to cash profit (EBITDA) to be within the group’s target range of 2-3 times at the full year.

    New products are the main future growth prospects. BATS has 3 global, market leading, brands in categories like e-vapour and heated tobacco. It’s early days for this division, but losses are reining in and profits are expected to flow in 2025.

    There are social risks associated with investing in tobacco, not least that the sector is excluded from some institutional products. The risk of regulators cracking down on new products is also worth being aware of.

    BATS trades on a valuation some way below its longer-term average and a re-rate looks unlikely given the declining volumes in traditional tobacco – still the core performance driver. Instead, the investment case lies on strong cash generation and the prospective dividend yield of 7.8% (variable and not a reliable indicator of future income).


    Acquisition machine

    Bunzl sources, consolidates, and delivers a range of essential products to businesses. Think food packaging, cleaning products and safety equipment – though that’s just the tip of the iceberg.

    Bunzl’s essentially a mashup of distribution businesses, around 150 in fact. Each business has local knowledge of customers and suppliers to allow a bespoke service at huge scale.

    Revenue at the half year came in at £5.7bn, with that expected to rise to £11.9bn at the end of the current financial year – a 16% rise on last year. Impressively, revenue’s grown at an annualised rate of 9% going all the way back to 2004. There’s no guarantee that continues.

    Organic growth so far this year has been driven largely by higher prices, and that’s expected to keep operating margins within the longer-term trend of mid-high single digits – no mean feat in the current environment.

    Rather than investing heavily in internal growth, Bunzl is a merger and acquisitions (M&A) machine. Most of the revenue growth over the last 10 years has been a result of acquisitions, with the group spending an average of £317m a year on acquisitions over the same period.

    M&A led strategies have their drawbacks. If the pool of target companies dries up or a business needs to raise external cash to fund acquisitions, then it’s not usually sustainable. Bunzl’s got the latter covered though. Acquisitions have been backed up by strong operating cash flow and the balance sheet’s in a strong position too.


    Source: Refinitiv Eikon correct to 15/11/22

    There’s a modest 2.2% prospective dividend yield on offer, which has an impressive history of growing at an annualised rate of 10% since 1992. No dividends are guaranteed.

    Bunzl may not be a household name, but underlying performance is impressive. A track record of doing well during tough times and steady growth are attractive qualities as economic uncertainty lingers. That hasn’t gone unnoticed though, with the group trading on a forward price to earnings ratio of 18.4, ahead of the wider sector.


    Cornerstone of the digital payments era

    PayPal’s long been a leading player in the digital payment arena, now operating through over 430m active accounts in over 200 markets.

    Total Payment Volumes (TPV) are the key driver of performance, at least at the revenue level. Headwinds are building for customers, but TPV growth’s still in the double digits over the year. PayPal’s expecting fourth quarter revenue of about $7.4bn, growing 9%.

    PayPal's a beneficiary, and indeed an architect, of an ongoing shift to digital payments that was materially accelerated by the pandemic. Yet, despite the scale, PayPal's flagship platform has a lot of market share it can go for, with consumer penetration below 50% in its core markets.


    Source: PayPal Q2 2022 Investor Update

    A robust balance sheet and free cash flow that's expected to exceed $5bn this year gives options. PayPal’s in a strong position to make acquisitions to reach new customers or distribute cash to shareholders.

    We’ve been pleased to see PayPal working closely with other enablers of eCommerce, rather than going head-to-head. Apple’s an example where work’s being done to help iPhones become a payment terminal for vendors. Moves like this reduce dependence on revenues from PayPal’s former parent, eBay.

    There are also plans to enable both PayPal and Venmo (owned by the group) credit cards to be added to Apple Wallets. This gives users further opportunities to choose PayPal as their preferred payment option, both online and in-store.

    The main risk to PayPal is a prolonged economic downturn that impacts spending. We see a lot of pain already priced into PayPal’s valuation, which is a good chunk below its long-term average. But the risk of further challenges for the shares remains very real. For those willing to accept the risks, PayPal could present an opportunity to invest in a leader in the electronic payment arena.

    Remember, to invest in US shares you’ll need to complete a W-8BEN form.

    Volvo Group

    On the road to income and growth?

    This isn’t the car company you might be thinking of. Today, Volvo is a truck and industrial equipment giant. Last year there were around 2.8m Volvo trucks, buses and machines rumbling around.

    We admire the group’s high barriers to entry - Volvo’s manufacturing and supply chains are enormous, expensive and complex, helping to protect market share. Volvo has enviable visibility over demand. The order intake for trucks was around 258,000 last year as customers replaced old trucks and expanded their fleets.

    Volvo not only produces vehicles, but services them. A 24/7 global servicing support network is a serious asset. If your truckful of goods is stuck somewhere, you need to have faith it can get moving ASAP. That feeds into more reliable revenue. Services currently make up just over a fifth of overall revenues, and is expected to increase to over 50% by 2030.


    Source: Volvo Group annual report, 2021

    The group’s also benefiting from booming e-commerce (those extra online orders mean increased need for logistics). Volvo is also a leader in the electrification of heavy-duty vehicles. Volvo wants over 35% of its vehicle sales to be electric by 2030. We view being a front-runner of sustainable haulage a real plus point.

    In the medium term, cost inflation and wider supply chain issues are problematic. We think taking a more cautious approach to new orders is the prudent thing to do. Volvo is an expensive business to run at the best of times, so underlying operating margins of close to 10% are the norm.

    The steadier style of Volvo’s revenue means it’s able to pay dividends, supporting a 5.1% dividend yield. The proportion of the group’s earnings paid as a dividend is low, which can make these payments more resilient in a downturn and provide scope for dividend growth. Please remember nothing is guaranteed. Overseas dividends can be subject to withholding tax which might not be reclaimable.

    We view Volvo as a steady-Eddie with longer-term growth and income potential. There are some immediate challenges around supply chains and inflation, which the market has priced in with the price to earnings ratio of 10.5 some way below the longer-term average.

    How to invest in these shares

    One way to invest for the long term is by using your ISA allowance.

    Shares held in a Stocks and Shares ISA aren't subject to UK income tax or capital gains tax.

    You can pay up to £20,000 into an ISA this tax year. There's a 0.45% charge for holding shares in the HL Stocks and Shares ISA, capped at £45 per annum. View our charges.

    Tax rules for Stocks and Shares ISAs can change and their benefits depend on your circumstances.

    Discover the HL ISA

    If you'd rather invest outside of an ISA, the HL Fund and Share Account is a low-cost, flexible alternative.

    It's free to hold shares in a Fund and Share Account. Whichever account you choose, share dealing costs a maximum of £11.95 per UK deal online. You'll also pay a foreign exchange (FX) charge for overseas shares. View our share dealing charges.

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    This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

    This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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