George Salmon, Equity Analyst 31 December 2018
2018 has been an eventful year, with Brexit and trade wars dominating the headlines.
The FTSE all share index has shed 12.5% this year, and while there have been winners and losers among our five to watch, they’ve suffered a similar fate as a collective. At the time of writing, they are down on average by 11.2% (excluding dividends).
Here, we take a look at what’s performed well, and what’s not.
IRN BRU maker AG Barr has been the stand out performer. Shares have risen consistently in an uncertain market, and the dividend has bubbled up too.
Trading has been bright (maybe even luminous) with recent results confirming there’s been little adverse reaction to the new lower-sugar recipe. That’s a clear positive, but hasn’t been the only factor in play.
Consumer goods companies are often seen as safe havens where investors can weather market volatility, and AG Barr is no exception.
While others’ fortunes might be tied to factors like oil or house prices, history tells us it’ll take quite something for wider economic factors to impact the Scots’ thirst for IRN BRU. A combination of unique flavour and irreverent marketing means the brand has grown steadily in its core market since the nineteenth century.
Looking ahead, we see little reason why Barr can’t keep up the good work. Still, investors should note that the strong recent performance means the shares trade on a premium valuation of 24 times earnings. That’s significantly above the long-run average of more like 18.6 times.
When we picked British Land as a share to watch, we said those in search of an income, and prepared to weather Brexit-induced volatility, might consider British Land.
The company has delivered on the income side, but as you might have gathered, there’s been a fair bit of Brexit uncertainty. We’re still no closer to knowing what the UK’s departure from the EU will look like, and that’s weighed on sentiment towards the sector.
In November the group of international investors that was due to buy fellow UK REIT Intu abandoned the move, citing the unfavourable climate. Since around half of British Land’s property portfolio is in the same commercial sphere as Intu’s, it’s no surprise the shares felt the shockwaves of that dramatic show of no confidence. That 5.8% jolt made sure they remain behind the wider market.
Perhaps with the prevailing uncertainty in mind, British Land has adopted a cautious strategy over 2018. Proceeds realised from asset sales this year have been divided between pushing the portfolio’s loan to value down to 26.7%, and funding an ongoing share buyback plan.
We think taking some risk off the table is a good move, and with the shares changing hands well below the net asset value of the business, we also like the decision to go with a share buyback over a special dividend.
As for the wider outlook, it’s a case of as you were. We think British Land has an attractive pool of assets, but Brexit will be the main driver of sentiment in the near term.
It’s been a game of two halves for Burberry.
The first half of the year brought healthy gains, as the strategy to reposition the brand at the very top of the value ladder gained traction with the market, while trading updates brought news of strong progress. That juicy combination helped the shares rise over 30% by late August.
While Burberry has still comfortably outperformed the wider UK market so far in 2018, escalating trade wars have seen the shares drop in the last few months.
President Trump’s angry rhetoric around China has bubbled over into protectionist policy, and that caused the Chinese to respond in kind.
While only 16% of Burberry’s sales are made in China, that percentage seriously underestimates the real importance of the country.
That’s due to the rise of the daigou, individuals best described as somewhere between a personal shopper and luxury trader. Daigous buy products in the west, taking advantage of lower costs or favourable exchange rates, before transporting them back to their own customers in China.
In addition to imposing extra tariffs, the Chinese government has increased its focus on this practice, and images of airport staff rifling through luggage looking for luxury goods sent shivers through the whole sector in October.
So while we’re yet to see anything to alarm us in Burberry’s numbers, we’d like a swift resolution to the ongoing game of tariff Top Trumps.
It’s been over four months since we had any detailed numbers from Legal & General (L&G), but those numbers confirmed healthy profit growth across the board.
Cash has continued to flow into L&G Investment Management, which is within touching distance of having £1trn of assets under management.
However, the retirement and annuity business, which accounts for 45% of group profits, is still the real driver of growth.
Annuities have seen their popularity collapse in recent years, but half year underlying operating profits rose 9% to £480m. That’s because growth is being driven by two relatively new product lines – bulk annuities and lifetime mortgages.
The bulk business, where L&G takes over responsibility for final salary pension schemes, has signed several notable deals in recent months – including the UK’s largest ever deal, with British Airways.
Meanwhile lifetime mortgages, a form of equity release, has gone from nothing to over £1bn of advances per annum in just 3 years.
Unfortunately the shares look like finishing the year in the red, despite the rosy numbers. That’s largely down to a de-rating which has seen the PE ratio fall from 11.1 In January to just 7.1 now.
The fall probably reflects the group’s exposure to the UK stock market, and a business model that’s very reliant on British savers – whose wellbeing is dependent on a positive outcome from Brexit negotiations.
But L&G revenues are also largely recurring, and that should help to underpin the dividend in the long term. The shares offer a prospective yield of 7.7%, and analysts expect that to grow in the years ahead. Still, given the market uncertainty that’s dented the share price in recent months, those forecasts are certainly not guaranteed.
To say we’re disappointed with Sophos would be an understatement. After several worse than expected updates, the shares look on course to close out the year well in the red.
The problem hasn’t been recruiting new customers – Sophos is still drawing plenty of new clients. The issues have instead arisen from what was expected from the existing customer base.
Underlying billings rose just 2% over the first half. While Sophos expects that growth rate to pick up a bit in the second half, there’s little chance we’ll get anywhere near the 18% underlying growth of last year.
Sophos says the miss is a result of lapping a bumper period last year. This means it failed to realise the extent of the boost from the WannaCry attack in 2017. As a result the renewals rate this year was much lower than expected.
As we move away from these tougher comparisons, billings should pick up. But the fact Sophos didn’t fully grasp the dynamics of the situation is a concern and raises serious questions about management’s grip on the business.
Looking further afield, IT security threats are only getting more sophisticated, so the market should keep growing. Servicing smaller businesses means Sophos has an attractive niche, and the group has proven capable of delivering excellent products. Therefore we think the long-term opportunity remains unchanged.
But there’s no getting away from the fact a turbulent 2018 has knocked investor confidence. Restoring that, by issuing and meeting more accurate guidance, will be the priority.
The author of the article holds shares in AG Barr, Burberry and Legal & General.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. 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.
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