Five shares to watch 2020 – Full Year review

Despite coronavirus cases rising in the last quarter, our five shares to watch actually enjoyed a very strong end to the year.

As of 21 December the five shares were, on average, up 8.5% over the year. That compares to a 9.9% fall in the UK stock market as a whole (with dividends reinvested). Past performance isn’t a guide to the future.

That result was driven by some very good results from Keywords, Novo-Nordisk and DS Smith, offset by weaker performances from Ibstock and WPP.

This article isn’t personal advice.

Investing in individual companies isn’t right for everyone. Our five shares to watch are for people who understand the increased risks of investing in individual shares. If the 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. If you’re not sure if an investment is right for you please seek advice.

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DS Smith – long-term attraction intact

DS Smith’s half year results, published at the start of December, showed early signs of a recovery at the cardboard box maker.

Revenues over the six months to the end of October fell 10%, but volumes have recovered more recently, coming in more than 5% above last year in November. Ecommerce and consumer goods companies make up 84% of total sales, which we think continues to be a key advantage. These customers have continued to trade through the crisis, and ecommerce in particular has boomed.

DS Smith’s high proportion of fixed costs and coronavirus related expenses meant profits this year slumped. It’s also a risk that lingers into the future – we’re not quite out of the pandemic woods yet. But lower levels of capital expenditure and good working capital management meant free cash flow actually rose 16%. That in turn drove a slight decline in net debt compared to the start of the year.

The combination of strong cash generation and a manageable debt position gave management the confidence to restart the dividend – analysts expect a yield over the next 12 months of 3.7%, although of course no dividend is guaranteed and yields are not a reliable indicator of future income.

While the pandemic means it’s not been the 2020 we’d hoped for, we’re generally pleased with how DS Smith has performed. Not only has it weathered the storm well, but the strength of the ecommerce and consumer goods sectors has shown the long-term attractions of DS Smith’s end markets.

The group now trades on a price-to-earnings (P/E) ratio of 13.6. That’s some 23% higher than a year ago, but we think profits could recover strongly in 2021 and remain positive in the longer term.

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Ibstock – still standing despite the COVID huff and puff

As a key supplier to the construction industry, in a year where much of the housebuilding sector was forced to cease production for an extended period, Ibstock has struggled. In share price terms, it’s the worst performing of our five shares to watch.

Sales fell 36% in the first half, and a relatively fixed cost base meant profits suffered even more. However, the process can work in reverse too. And we think the group could emerge well from the pandemic. As a result, we’ve rolled the company over into our five shares to watch in 2021 – the first time we’ve ever done so.

In the depths of the crisis Ibstock took steps to reduce expenses – trimming £20m off the 2021 cost base through job losses and closing some poor performing plants. Recent sales figures have shown a sharp recovery. September and October sales have been back up at 90% of last year’s. Recovering sales on a lower cost base should mean good news for profits.

The pandemic has left scars though. Net debt rose from £85m at the start of the year to £103m in June. Management expect to shrink that by the year end, but debt reduction could eat up surplus cash in the short term.

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We think Ibstock has more to offer over time. In particular it should benefit from government plans to spend billions on housing and infrastructure.

Ultimately, an investment in Ibstock is a vote of confidence in the UK economy. Relatively little exposure to house prices helps moderate the downside, while government support presents growth opportunities. Hopefully 2021 can deliver what 2020 failed to.

Read our Five Shares to Watch in 2021 for more detail on why we remain positive on Ibstock

Keywords Studios – rapid growth, but valuation makes us nervous

Video game outsourcer Keywords has been the standout performer among our five shares this year.

However, a lot of that is down to the group’s price-to-earnings (P/E) ratio rising to 48.1, as at 29 December. That’s 68.8% higher than a year ago. By comparison organic revenues rose 8% and underlying earnings per share rose “just” 17.3% at the half year stage.

Had you told us back at the start of the year that Keywords would be able to deliver that kind of growth, despite all the disruption, we’d have been quite happy. Especially as the group sold €110m of new shares during the year and completed seven acquisitions.

The group’s end customers, namely video game publishers, are having a bumper time. With Keywords being a key provider of services into the industry, that can bode well for the future. However, at the new, much higher valuation we are nervous.

Analysts are forecasting average annual revenue growth of just 14% between now and 2022 – and while impressive, we don’t think that’s enough to justify the current rating. Keywords has to deliver results well ahead of market expectations if the shares are to avoid de-rating and a painful share price fall. Of course, it might exceed all expectations and continue to outperform, but past performance isn’t a guide and we think there are less risky opportunities elsewhere.

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Novo-Nordisk – still distinctive

Pharmaceutical giant Novo-Nordisk has had a reassuringly uneventful year. GLP-1, insulin free diabetes treatments continue to drive steady revenue growth (up 7% in the third quarter), more than offsetting weakness in US insulin sales.

We think that trend can continue going forwards. A very healthy balance sheet, which includes over 21bn Danish Kroner in net cash, also underpins the 2.2% yield. Remember yields are variable and not a reliable indicator of future income.

It's not all smooth sailing though.

Pressure on insulin pricing in the US could gather pace under a Biden administration, creating a headwind to future growth. Competition is heating up in the smaller haemophilia business too. So far new products and international expansion are more than offsetting those headwinds, but it's something to keep an eye on.

As things stand, we think Novo’s fundamental attractions are unchanged. Pharmaceutical companies with net cash on the balance sheet, a defensive market and reasonable yield, are few and far between.

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WPP – challenges outweigh opportunities

Of all our five shares to watch, WPP has been by far the most disappointing. While it’s not the worst performing financially, the core advertising business was struggling before the virus struck and has not performed well in the months since.

Having said that, a strategy update in mid-December was well received by the market.

The update set out plans for cost savings and future investment. A target of £600m in cost savings between 2020 and 2025, should help support profits over the medium term. The group’s also committed to paying out 40% of profits as a dividend and resuming share buybacks from the proceeds of the Kantar sale. That’s despite a significant step up in capital expenditure (mostly into WPP campuses and improved technology) and a return to acquisitions.

WPP has options, partly because its balance sheet has been flooded with cash by the sale of Kantar and partly because it’s an inherently cash generative business. But while the new commitments are certainly positive developments, this year has proven that ambition and execution are two very different things. The group still has a lot of work to do.

Unfortunately that work comes at a time of significant upheaval for the wider marketing market as digital giants like Facebook, Amazon and Google take an ever larger slice of the advertising pie. WPP used to be gatekeepers between would-be advertisers and the media outlets the advertisers paid. But increasingly that middle-man role is unnecessary. The group has moved to adapt – shifting into data, PR and more specialist segments.

However, the combination of changing end markets and significant restructuring is a risky combination. For investors willing to take on extra risk there’s a chance the restructure pays off. But at the end of a difficult year we think WPP’s challenges probably outnumber its opportunities.

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Data correct as at 22 December unless otherwise stated.

This article is not personal advice or a recommendation to buy, sell or hold any investment. If investors are not sure of the suitability of an investment for their circumstances, they should seek advice. 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. 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 and investments rise and fall in value so investors could make a loss.

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.

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