3 stocks that don’t rely on the digital revolution

There’s no denying that the digital revolution is well underway. Everything from buying cars, to ordering your pub grub has shifted online, a shift accelerated by the pandemic.

But while technology is certainly having an effect on every sector, not everything is going digital.

There are plenty of businesses out there that rely on old school, face-to-face behaviours. The kind of services we don’t think will date in the same way others will. Trusting in these companies could offer opportunity.

Please remember there are no guarantees, and this article isn’t personal advice. If you’re not sure if an investment is right for you, ask for advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

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Dixons Carphone

Dixons is an old-school-cum-digital hybrid. The pandemic forced the electricals specialist to speed up its pivot to digital customer service and sales. But what’s underpinning that digital success is its secret weapon: face to face service.

People want to talk to a knowledgeable store assistant when it comes to buying a new laptop or washing machine. Despite UK and international store closures and restrictions, full year electrical sales actually rose 14% last year, helped by online sales more than doubling to £4.5bn. That’s no doubt been helped by the 24-hour ShopLive proposition, which connects shoppers to real life colleagues for product demonstrations.

The group also expects to report a net cash position of £150m at the full year. That’s something we certainly didn’t predict heading into the crisis.

Those service-driven salespeople could be kept busy for a while longer too. The pandemic has created a new culture of home working and home improvement, which could bode well for Dixons.

The efforts to restructure the business have also been commendable. The longer-term strategy is to out-do online rivals by offering a top-tier face-to-face service and multiple product categories under one roof. The crucial service element is what – in theory – will help Dixons charge more for its products.

Which takes us to the less positive side of things. Mammoth competitor Amazon still looms large, and there’s an argument that people will simply shop wherever it’s cheapest. As this dynamic unfolds it will be important to keep an eye on operating margins, which at just under 2%, are too thin for comfort.

While we’re coming to the end of the worst of social restrictions, there’s still plenty of uncertainty. That’s why dividends aren’t a priority at the moment. Nonetheless, analysts are predicting a yield of 3.4% over the next 12 months. But remember, yields are variable and aren’t guaranteed. They’re also not a reliable indicator of future income.

The price-to-earnings ratio of 11.5 is broadly in-line with the ten-year average. That reflects the fact Dixons is in a state of flux, and things could go either way. We think Dixons has made some great strides and could stand the test of time in a tough market. As ever though, this isn’t guaranteed, and near-term challenges do exist.

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Disney

You can’t ride space mountain in your living room. And your kids can’t visit the magic kingdom on the local high street. Disney is protected from enduring old-school thrill-seekers.

Pre-pandemic, Disney’s theme parks and consumer products made up around 37% of the group’s $70bn annual revenues. Unsurprisingly, the parks took a beating last year, with the gates forced to close. In testament to Disney though, analysts currently expect parks and consumer products revenue to overtake pre-covid levels by 2023.

That leads us nicely to Disney’s biggest asset: intellectual property. It’s not just that Disney runs theme parks, it’s that they’re Disney theme parks. The group’s brand is arguably one of the most potent in the world. That’s what will help shelter it over the long term, although there are likely to be some ups and downs along the way.

This enviable hoard of intellectual property and loyal fans is why Disney has been able to do so well with its entrance to the streaming market. With 159m subscribers across Disney+, ESPN and Hulu, it boasts 75% of the number of Netflix’s subscribers, despite being much later to the party.

Seeking entertainment from our homes is also a behaviour unlikely to change, and Cinderella simply won’t age as quickly as a Netflix original film will. That should have a positive effect on cashflow in the future, because Disney isn’t under as much pressure as its peers to constantly create new and expensive content.

Notice we said “should” – the immature streaming business isn’t there yet and is currently losing money. While it’s an exciting opportunity, keep in mind this isn’t a net benefit for profits at this time.

We shouldn’t underestimate the challenges of the last year either. The balance sheet has faced some blunt force trauma, not least because it was already stretched following the enormous $71bn acquisition of Twenty First Century Fox.

Net debt was a whopping 13.5 times cash profits in April 2021. That’s partly because of the enormous fixed costs that come with running mega holiday parks, cruises and hotels. Provided restrictions unwind within a reasonable timeframe, that debt pile should be manageable – but it’s something to keep an eye on.

We think Disney’s investment case remains more at the belle-of-the-ball end of the spectrum. That’s helped by the fact its irreplaceable brand and physical experience-based products are unlikely to be usurped, even in a new digital age.

A price to earnings ratio of 43 is more than double the ten-year average though. So investors are paying for that strength, and they should be prepared for some medium-term ups and downs.

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Diageo

Diageo produces and distributes some of the world’s most famous alcohol brands. Names include Smirnoff, Johnnie Walker, Guinness and Tanqueray. Its products are sold in over 180 countries, and distributed to pubs and restaurants, as well as supermarkets.

This is where Diageo has an advantage. We could have put a pub group on this list, as beer gardens and fire-side Sunday roasts aren’t likely to be something we give up. But in times of hospitality slumps – such as in economic downturns – Diageo has an extra source of revenue from shops.

The fact it operates all over the world offers some diversification too, which can partially smooth some bumps.

In the 2020 financial year, Diageo’s organic sales fell 8.4%. That doesn’t sound ideal, but in the scheme of things that’s a fairly modest decline considering a huge chunk of its customers weren’t trading in the second half. Sales in North America actually rose, which is what helped stem the sales outflow.

A more predictable revenue stream – although nothing is ever guaranteed – is what has helped underpin the prospective dividend yield of 2.1%. Analysts predict dividends per share of 70.7p this year, which seems comfortably covered by earnings. There could be scope for some surprise on the upside. Remember though, no dividend is ever guaranteed and yields are variable and aren’t a reliable indicator of future income.

The group’s also restarted its £4.5bn share buyback programme, which is a mark of confidence in its recovery – but we’re slightly dubious as the share price valuation of 27.2 is an all-time high. We’d be more supportive if funds were channelled in the form of bigger special dividends.

The other bugbear is debt. Efforts are going into bringing debt down, but management still expects the net debt to underlying cash profits (EBITDA) ratio to be around 3.0 times by the end of June 2022. The situation isn’t untenable, but it could limit investment elsewhere for a little while to come.

Diageo is likely to be a steady-Eddie rather than a spectacular growth story. But digital disruption is unlikely to upend demand for liquor cabinet staples. Together with its global footprint, we think Diageo could be worth considering for those prepared to accept the external risks the current valuation entails.

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Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments and income they produce can 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.

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