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Five shares to watch 2023 – third quarter update

As we near the end of the year, we check in on how our five shares to watch have performed in the third quarter.

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.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

As 2023 draws to a close, inflation is finally on its way back down. That means we’re likely at, or near, the end of the current interest rate hiking cycle.

But as we head into the winter months, oil and gas prices are trending higher. That adds some upward pressure on inflation and central banks are set to hold interest rates high well into next year.

High rates are typically bad news for stocks, but shares have fared reasonably well in 2023. In the US, performance continues to be led by a handful of mega cap names.

It’s an ever-changing picture and one that we’ll be monitoring closely. Here’s how our five shares to watch have been doing in the third quarter, and what could be next.

This article isn’t personal advice. Investments and any income from them 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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BAE Systems

We’re expecting another steady quarter from BAE Systems (BAE) to cap off 2023.

In the first half, order intakes were almost double the group’s £12.0bn of sales, which helped push the order book up to an incredible £66.6bn. This gives good visibility of future revenues and highlights the key space BAE occupies in the defence market.

The group should also stay relatively resilient to rising prices. BAE can normally pass on most of the rising input costs to the end consumer for a lot of its contracts. In this case, that’s governments who have very deep pockets.

Full-year sales and profit guidance were upgraded at the half-year mark, both getting nudged 2% higher to ranges of 5-7% and 6-8% respectively.

But the big news last quarter was the $5.55bn cash acquisition of US-based, Ball Aerospace.

Ball Aerospace has strong positions across the defence, spacecraft, and intelligence community. This move increases BAE’s footprint in the US, a key market for future growth in a nation whose defence spending dwarfs any other country.

The deal is expected to close in early 2024, and if all goes to plan, should add more than $2bn to BAE’s top line every year.

The shares now trade on a forward price-to-earnings ratio of 15.6, above the long-term average. That’s a sign of confidence from the market but increases the risks of ups and downs should there be any missteps.

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British American Tobacco

British American Tobacco's (BATS) first-half results painted a mixed picture.

Organic revenue grew 2.8% to £12.8bn, ignoring the effects of exchange rates. This was driven by a 27.9% increase in new categories, which are expected to become profitable in 2024.

Meanwhile, sales from combustible products were up just 0.4% where strong pricing offset a 4.9% decrease in volumes. Weakness in the US was offset by performance in other territories.

Management has maintained full-year guidance of 3-5% organic revenue growth and a mid-single figure uplift in underlying earnings per share.

BATS will need to do better in the second half to meet these targets. A continuing recovery in key US combustible brands and further growth from new categories could help here.

There was also a renewed commitment to the company’s 65% dividend pay-out ratio which is some comfort that the prospective yield of 9.0% is achievable. As ever, no dividends can be guaranteed, and for now buybacks remain off the table.

We think the key driver of how quickly they’ll return is the speed at which BATS can reduce its considerable debt pile – this was close to £37bn at the last count.

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We included Bunzl as a high-quality business with defensive qualities and it has done well so far this year. But explosive growth was never the main attraction.

Bunzl's a mashup of around 150 distribution businesses, which source and deliver a range of essential products. Both revenue and adjusted operating profit have grown at an annualised rate of 9-10% going back to 2004.

Growth in 2023 will be harder to come by than 2022, but a strong performance during tough times has been particularly impressive.

Recent organic performance has been largely propped up by higher prices, which have been essential as a tool to keep inflated costs from eating into margins.

For now, Bunzl sits in a nice spot, inflation's still lingering enough to keep selling prices up, but falling costs mean margins have room to expand.

Acquisitions are the real growth driver here, propped up by strong cash generation. After a slow start to the year, deals have been coming thick and fast.

In the first half, Bunzl committed to spend over £350m on 12 acquisitions, with those deals offering substantially higher margins than seen in previous years – likely one of the reasons profit guidance got pushed higher back in August.

Bunzl remains a strong pick, but there are no guarantees. The key thing to watch is how organic growth plays out from here. Any weakness in this area puts added pressure on acquisitions to do the hard work.

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PayPal expects third-quarter revenue growth to stay broadly in line with the 8% we saw in the second quarter, ignoring currency movements.

For the full year, previously downgraded operating margin growth guidance remains at 1 percentage point. Full-year underlying earnings-per-share guidance is also unchanged at $4.95.

Unbranded transactions, which allow merchants to put their own name to the payment solution, continue to increase their share of PayPal’s business mix. The lower margins on these activities was one of the factors that drove second-quarter underlying profit margins down to 21.4% from 22.7% in the first quarter.

Cash flows have also come under some pressure. This is in part due to the increasing popularity of buy-now-pay-later solutions. The decision to sell over $40bn of these loans to a private equity firm is a step in the right direction in our opinion.

We’ve also seen the emergence of a new man at the helm with the appointment of Alex Chriss as CEO and President. Consumer spending, the engine of the business has remained relatively resilient in the face of high inflation and rising interest rates.

There are some signs that this resilience is fading, particularly in the US. That means he could well have his work cut out if he’s to return PayPal’s growth rates to their former glory.

Remember, before you can trade US shares, you need to complete and return a W-8BEN form.

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Volvo’s been able to increase prices which has helped profits rise significantly.

The group’s valuation has seen a 17% uplift in the year to date, with the most recent quarter being especially positive. This is largely related to the fact that the worst of inflation concerns have been put to bed, which reduces uncertainty.

Volvo's net sales rose 11% to SEK140.8bn last quarter, reflecting growth in all business areas – ignoring the effect of exchange rates. Net sales from all the group's different vehicles rose to SEK109.3, up from SEK92.2. Net sales from Services were up almost SEK5.0bn at SEK31.5bn.

Crucially, Volvo updated the market with comments that larger truck fleets are continuing to upgrade their vehicles, which is a long-term growth area.

At the same time, the group cautioned that smaller operations were becoming a bit more cautious, owing to the tougher economic climate.

This is something to monitor, but it’s not something we’re overly cautious about at the moment. Order intake volumes are down 10% and we’re optimistic these volumes will recover, remember nothing’s guaranteed though.

Volvo’s fundamental strengths remain in place in our opinion. A long-term order backlog and an offering of essential, specialised equipment continues to hold the group in good stead and helps underpin dividend payments.

Remember though, no dividend is ever guaranteed. Overseas dividends can be subject to withholding tax which might not be reclaimable.

Find out more about Volvo shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated, estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates aren’t 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.

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