3 stocks with recovery potential

Recovery has been the buzzword of the moment, as the pandemic starts to recede in parts of the world. That’s because of the wide range of quality businesses that faced temporary setbacks when lockdowns were imposed. But normality feels within reach as vaccination uptake improves and that’s helped lots of these companies recover to near-normal levels.

That’s made it more difficult for investors to find plausible recovery stories. But that doesn’t mean there aren’t any. Here’s a look at three stocks that we think have the potential to pull off a U-turn in the year ahead.

This article isn’t advice or a recommendation to invest. Remember, investments can go down as well as up in value, so you could get back less than you invest. If you’re not sure if an investment is right for you, seek advice.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Delta Airlines

The pandemic created a challenging environment for airlines

For short-haul carriers, which cater to leisure travellers and holiday destinations closer to home, the recovery from pandemic lows has already materialised. For the long-haulers, business clients are yet to return in force. And holiday makers are still battling against differing Covid-19 restrictions at further-flung locations around the world. All-in, weaker growth could linger well into the future.

There aren’t many airlines that fall somewhere in between the two, but Delta Airlines fits that bill. The bulk of the group’s revenue comes from domestic US travel – this was true even before the pandemic hit. So, the lagging recovery in long-haul hasn’t hit the group quite as hard. That means it has a stronger foundation to stand on as it restores its long-haul operations over the years ahead.

Although domestic travel numbers are proving much more resilient than long-haul, it’s not enough to offset the challenges. That means the group will likely suffer another multi-billion pound operating loss this year.

This is the reason Delta’s share price is still some way off its pre-pandemic level. And the market’s jitters are somewhat understandable.

Net debt has crept uncomfortably higher, but we don’t have any short-term liquidity concerns. Profits are expected to make their way toward normal levels over the next few years. Plus, as CEO Ed Bastian recently pointed out, flying is about to get more expensive amid climate change regulations. This could put Delta in a stronger position than its low-cost peers because its business clients are likely to be less price-sensitive.

If the pandemic worsens and travel restrictions tighten once again, this could change for the worse. But if not, we think the group looks on track to pull off a recovery over the next two years.

VIEW THE LATEST DELTA AIRLINES PRICE AND HOW TO DEAL

Rio Tinto

You might expect Rio Tinto to have already enjoyed a recovery. That’s because investors often turn to miners when inflation worries are on the table.

But Rio’s share price has fallen considerably as worries about the group’s substantial iron ore business weigh on sentiment.

This is a fair concern – iron ore is a key component in steelmaking, which is a relatively ‘dirty’ process environmentally speaking. As governments around the world commit to reducing their impact, cutting back on steel production – as China recently announced – is bad news for iron ore prices.

Aside from the environmental concerns, there are wider economic worries as well. Weakening economies don’t build skyscrapers, lowering demand for new steel and the raw materials that go into making it.

But there are reasons to be optimistic about Rio’s longer-term future. Most notable is the group’s low production costs.

It costs Rio about $18 to mine each tonne of iron ore, substantially lower than peer Anglo American. Even in 2015, when prices reached an all-time low, the group was able to sell the stuff for more than double that. The group’s unlikely to find itself in dire straits, even if things don’t immediately turn around.

A prolonged period of depressed iron ore is a risk investors have to take into account. However, the group’s prospective dividend yield of over 11% suggests patience could be rewarded – but perhaps not to the extent that yield first suggests. Remember, yields are variable and aren‘t a reliable indicator of future income.

Either the environment will be so difficult to operate in that the dividend might be trimmed. Or, the shares will rise in value, which ultimately lowers the yield. We think the latter is the most likely scenario. But of course, like yields, this isn’t guaranteed.

Rio is in a good position to weather a decline in iron ore prices, and investors could be rewarded for their patience. If conditions improve, the group’s low unit costs mean it’s also in a great position to turn the added revenue into profits.

VIEW THE LATEST RIO TINTO PRICE AND HOW TO DEAL

SIGN UP TO RIO TINTO RESEARCH

GlaxoSmithKline

Pharmaceutical company GlaxoSmithKline is nearing a crucial turning point. The group’s embarking on a major strategy shift that will see the consumer business separated from pharmaceuticals. If successful, this should leave behind two better businesses with more manageable debt obligations.

Strategy shifts of this scale rarely go off without a hitch though, which explains the group’s muted valuation. Its price to earnings ratio is currently at 13.2, roughly in line with the long-term average, but below that of peers.

Glaxo’s net debt position is a whopping £22.1bn. With the prospect of rising interest rates on the horizon, this is a concern. However, NewGSK, which will be made up of the pharmaceutical business will strike out on its own with a relatively small debt pile, worth roughly two times cash profits. The rest will go to the newly single consumer healthcare business, whose relatively stable revenue and minimal investment requirements will make it more manageable to pay down over time.

Shareholders get shares in both companies, but neither will pay a particularly impressive dividend. The prospective yield for both is 3.7%. That’s not nothing, but considering GSK shares have been yielding upwards of 5%, it’s understandably disappointing. Yields are variable and not guaranteed.

But aside from the restructure’s impact on debt, there are some opportunities pinned to NewGSK.

The group’s monoclonal antibodies treatment for Covid-19 could prove an important tool in the fight against coronavirus moving forward – particularly with evidence showing vaccine effectiveness fades over time.

The US government has just placed a $1bn order for the treatment, and if coronavirus is to stick around, this could be the first of many. Plus, roughly a third of the group’s pipeline is in late-stage development and it’s also got a strong portfolio of patented respiratory and HIV drugs underpinning revenue.

This is made all the more appealing when you look at GSK’s ability to turn sales into profits. With operating margins at 23%, the group’s ahead of peers. Return on equity, a measure that tells you how efficiently shareholder cash is turned into profits, is an impressive 44% – well beyond other industry leaders.

GlaxoSmithKline has potential if all goes as planned over the next year. The ‘if’ is doing a lot of work here though. The drug approval process is uncertain at best, and there’s no guarantee the split will go off without a hitch. Still, we think GSK shares offer an opportunity for investors willing to stomach those risks.

VIEW THE LATEST GLAXOSMITHKLINE PRICE AND HOW TO DEAL

SIGN UP TO GLAXOSMITHKLINE RESEARCH

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. Past performance is not a guide to the future. 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.

Share insight: our weekly email

Sign up to receive weekly shares content from HL.