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Five shares to watch 2021 – third quarter update

We take a look at how our five shares to watch for 2021 have performed so far this year: CVS Group, Diageo, Facebook, Ibstock and Tesco.

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.

With mass energy shortages, oil price surges and inflation fears creeping back into the fold, it’s been an eventful third quarter. Even with these uncertainties, stock markets around the world have actually held up pretty well.

Rising markets in the UK and across the pond means all five of our shares to watch this year are showing positive returns at the end of the third quarter.

Of the five, Ibstock has performed worse than the overall market, while CVS Group, Diageo, Facebook and Tesco have all delivered market beating results so far.

This article isn’t personal advice. Investments can fall as well as rise 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. Past performance isn’t a guide to future returns.

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.

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CVS Group

As we hoped, increasing pet ownership has provided a very favourable backdrop for Vet group CVS this year. Around 3.2 million UK households bought a puppy or kitten since the start of lockdown. This provided a short-term boost to like-for-like revenues, which rose 17.4% in the 12 months to 30 June 2021, from first consultations, vaccinations and neutering procedures.

However, we expect increased pet ownership to provide support over the medium term too. Pets tend to have more than one trip to the vets in their lifetime, meaning they’re a recurring source of income.

Increased activity has led to some challenges in finding qualified staff, with vet vacancies over the 12 months to the end of August up from 6.8% a year ago to 8.8%. That’s led to increased pay and holiday allowances. Despite those extra costs, the group still managed to grow underlying profit before tax by 73.3%. That reflects strong growth in non-veterinary services like MiPet pharmaceuticals, laboratories, crematoria and online retail.

Sales since the end of the financial year have also been encouraging, with the two months to the end of August seeing sales rise 17.5% year-on-year.

Clearly this is all very welcome. However, we worry that the positives are now more than baked into the share price. The shares trade on a prospective price to earnings ratio of 30.1, more than 50% above the stock’s ten-year average of 19.1. With the initial pandemic boom likely to fade over the next 12 months, we see that as quite an ask.

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Diageo

Diageo’s full year results, covering the year to the 30 June, showed strong organic volume growth – up 11%. This was thanks to growth across all regions, but mainly because of the strong results in Africa and Latin America.

At the product level, all categories except rum reported year-on-year growth, with tequila by far the strongest performer with volumes up 70%. As with many spirits across the portfolio, tequila brands Don Julio and Casamigos benefited from their occasion appeal and bars opening back up.

Operating profits leapt 74.6%, benefitting from the exceptional items recorded during the early days of the pandemic not reappearing. That was despite a significant 23% increase in marketing spend.

The group thinks volumes and revenue will continue to recover into the current financial year, driven by the continued unlocking of the global economy. Analysts expect full year revenues to rise 7.5% in 2022, slowing to around 5% a year as conditions return to normal.

If successful, that would suggest steady, if unexceptional, growth in the current 2.1% dividend yield going forwards. Of course no dividend is guaranteed. Yields are also variable and not a reliable indicator of future income. That might feel like a slow return for investors used to recent heady market results. However, we think the group continues to offer investors access to an incredibly high-quality portfolio of brands, across a diverse range of market segments.

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Facebook

Facebook’s second quarter results showed very strong growth in revenues (up 56% year-on-year) in the three months to the end of June. That reflects steady user growth, up 7% at Facebook and 12% across all brands, and a significant increase in average revenue per user as Facebook hiked its ad prices.

Operating profits more than doubled to $12.4bn, since higher ad prices feed directly through to profits, and investment in technical and product talent lagged revenue growth.

Growth over the remainder of the year is expected to moderate, as the group laps very strong growth in the same period last year. Changes in regulations are also a growing headwind to ad targeting and therefore to revenue, and that’s before the more existential investigations into how the group uses its data.

Those somewhat gloomy updates probably explain why the shares trade on a price to earnings ratio of 22.0 – some 30% below the group’s average since listing.

However, with something like Facebook it’s easy to get caught up in the political headlines and lose track of the money. With customer numbers growing and advertisers prepared to splash the cash despite increased restrictions, we think the group’s immediate future still looks positive. If the huge and largely unmonetised audience in WhatsApp can be made profitable, then the long-term outlook could be pretty interesting too.

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Ibstock

Brick maker Ibstock reported half year revenues of £202m in early August, just 1% behind pre-pandemic levels. Profits before tax are trailing just 4.9% below 2019.

While not as impressive as some of our other shares to watch, we see this as a significant achievement – especially given the potential for input inflation and supply chain disruption to upset results. Investment in new capacity is expected to boost output back to 95% of 2019 levels next year, following the closure of older plants during the pandemic.

With the UK housing market still buoyant, we think the outlook for demand is positive and should allow the group to pass higher input costs onto builders. Given the increased operational efficiency achieved during the pandemic, that bodes well for future profitability.

However, a price to earnings ratio of 13.2 is modestly ahead of the average 12.7 reported since the group listed in 2015. And, as is the case with all businesses connected to the housing market, the group’s at the mercy of the wider economic cycle. If things take a turn for the worse and housing activity falls, Ibstock will suffer.

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Tesco

Since our last update on the five shares to watch, Tesco have published a set of quarterly results – covering the three months to 29 May.

Operationally, the group has published some good numbers – with sales 8.1% ahead of pre-pandemic levels. That reflects a lasting increase in the number of meals eaten at home compared to pre-pandemic and very strong growth in online sales – which in the UK are 81.6% ahead of 2019 levels. Customer satisfaction is high, helped by increasingly competitive pricing.

However, it’s notable that the group has so far been left out of the mergers and acquisitions whirlwind that’s swept through the sector. In the last 12 months, Asda, Morrison and Sainsbury have all either been bought out or are rumoured to have been approached about a possible takeover.

The interest in the sector will have done the shares no harm, and probably explain why the group’s PE ratio has climbed to 12.8, ahead of the 11.5 long-term average. However, we do worry that reinvigorated competition following acquisitions could make an already competitive industry even tougher.

Subsequent to the end of the quarter Tesco have published half year results. You can find our most recent thoughts here

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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.

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    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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