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Five shares to watch for 2018

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Important - The value of investments can fall as well as rise, so you could get back less than you invest, especially over the short term. The information shown is not personal advice, if you are unsure of the suitability of an investment for your circumstances please contact us for personal advice. Once held in a SIPP money is not usually accessible until age 55 (rising to 57 in 2028).


George Salmon & Nicholas Hyett

Equity Analysts

A year from now we'll hopefully have an idea of what Brexit will look like.

Pretty much any outcome seems possible at the moment. Our share choices for 2018 reflect that uncertainty.

Income features prominently. Unlike share prices, which swing as sentiment shifts, dividends are comparatively stable, although certainly not guaranteed. Remember all investments can fall as well as rise in value so you could get back less than you invest.

We hope the below provides food for thought going into a crucial year for the UK economy. This article is not advice or a recommendation to buy, sell or hold any investment.

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Investment idea #1

AG Barr - quality at reasonable value

  • Owner of Irn-Bru - leading brand with loyal customers
  • High family ownership with board focusing on long-term
  • Valuations attractive compared to competition

AG Barr's drinks range stretches from Rubicon to Tizer. But the luminous orange Irn-Bru is by far the most important.

The Glaswegian tonic 'made from girders' is one of a tiny number of soft drinks to have denied Coca-Cola top spot in its home market. On sale since 1901, a combination of unique flavour and irreverent marketing means Irn-Bru continues to grow.

Famously sugary, there were fears a new sugar tax due to be introduced in April, and increasingly health conscious consumers would weigh on Irn-Bru sales. But with the recently launched zero sugar version selling the equivalent of 20 million cans in its first six months, it looks like customers will stay loyal.

The Barr family remain heavily involved in the business. Former Chairman Robin Barr is a non-executive director, and collectively the family control 18% of the company. Perhaps the best evidence of the family's ongoing involvement is that of the three individuals who know the top secret Irn-Bru recipe, two bear the Barr name.

We tend to favour companies with significant family ownership. The desire to pass the business on to the next generation means the board focuses on the long term.

That might explain why AG Barr is debt free and has grown or held the dividend every year since the late 90s.

AG Barr is expected to yield 2.6% in 2018/19, although as ever this is not a reliable indicator of future income, and past trends may not continue.

AG Barr lacks the stellar growth potential of a company like Fevertree. Nonetheless, revenues are up 8.8% so far this year and the group trades on a price to earnings ratio only 7% above its long-term average. This comes at a time when many rivals are on valuations with a bit more fizz.

Dividend per share (pence)

Past performance is not a guide to future returns

Source: Thomson Reuters Eikon, 27/11/17

AG Barr price and charts

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AG Barr
  • Owner of Irn-Bru - leading brand with loyal customers
  • High family ownership with board focusing on long-term
  • Valuation attractive compared to competition

See price and charts


Investment idea #2

Legal & General - a healthy dividend with scope to grow

  • Ageing population driving growth for core services
  • Company looking to expand into the US
  • Impressive track record of pre-empting market trends

We think Legal & General (L&G) can offer a sizeable dividend today and future growth. That's quite unusual - although of course not guaranteed.

L&G provides life insurance and retirement services to over 10 million people, mostly in the UK. An ageing population has driven growth across this sector. But L&G has done an impressive job of pre-empting wider market trends.

It was an early entrant into low-cost tracker funds, and now manages £331.5bn of index trackers.

Simple, low-cost funds are particularly attractive to companies who now have to provide an employee pension scheme under the automatic enrolment scheme. This has delivered most of L&G's 2.2m personal pension customers. Both employer and employee contributions are set to rise, making this a growing source of profits.

The group has also benefited from the gradual decline of the final salary pension. Huge pension deficits leave companies having to stump up cash to plug the holes. L&G helps these businesses avoid this problem by creating investments that match future pension payments and, increasingly, buying out schemes altogether.

It's still early days, but the potential market is worth an estimated £2trn in the UK, and L&G is looking to expand in the US.

Recent trends suggest old pension schemes could be even more profitable than first thought. Life expectancy gains have flattened out recently, and as a result liabilities are proving smaller than expected - leaving L&G with a £126m boost at the half year.

All this is set to drive growth. Bulk annuity deals are lumpy and capital intensive, but a recurring revenue base should make profits fairly predictable. That underpins a dividend that in 2016 could have bought a small FTSE 250 company, with a prospective yield of 6% (variable and not a reliable indicator of future income).

Breakdown of aggregate total wealth in the UK

Source: Office for National Statistics, 2015

Legal & General price and charts

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Legal & General
  • Ageing population driving growth for core services
  • Company looking to expand into the US
  • Impressive track record of pre-empting market trends

See price and charts


Investment idea #3

British Land - Brexit exposure but long-term income

  • Good visibility of future rental income
  • Shares trading at 20% discount to long-term average
  • Prospective yield of 4.8% (variable, not a reliable indicator of future income)

British Land owns properties including shopping centres from Glasgow to Plymouth, and prime central London offices. Together, they cover an area equivalent to 328 Wembley pitches.

The group is a Real Estate Investment Trust, or REIT. This means it's legally required to return 90% of its rental profits to investors as dividends, and that can make for an attractive income.

With 97.6% of its buildings occupied, and an average lease that has eight years to run until first break, future rental income is very visible. A high quality, blue-chip tenant base should mean income is able to weather downturns.

However, with lots of exposure to financial services, and the drop in the pound squeezing consumers, Brexit fears are weighing heavily on the stock. Asset values have so far proven resilient. But a retreating share price has left the shares trading at a price-to-book value of 0.7 times, a 20% discount to its longer-term average.

A depressed share price means the prospective yield is higher than it might otherwise be, currently at 4.8% compared to roughly 3.8% if it were trading in line with its longer-term valuation. The risk is a disorderly Brexit, which could mean capital values have further to fall.

Those in search of an income, and prepared to weather Brexit-induced volatility, might consider British Land. Lower debt levels suggest management have half an eye on an uncertain outlook. But the company clearly thinks its shares are good value at present, reinvesting proceeds from recent sales in a £300m share buyback.

British Land Net Asset Value Per Share (pence)

Past performance is not a guide to future returns

Source: Bloomberg, 27/11/17

British Land price and charts

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British Land
  • Good visibility of future rental income
  • Shares trading at 20% discount to long-term average
  • Prospective yield of 4.8% (variable, not a reliable indicator of future income)

See price and charts


Investment idea #4

Sophos Group - benefit from the cyber threat

  • Protects small and medium sized businesses against cyber attacks
  • Market worth £40bn and growing quickly
  • Over 100m users in 150 countries

A string of high-profile hacks mean the consequences of not investing in cyber security are all too evident.

Perhaps no surprise then, that companies are scrambling to shore up their cyber defences. Sophos Group, a company providing software to protect small and medium-sized businesses, should benefit from this.

The group uses a network of over 30,000 independent partners to sell and distribute its products. Over 100m users in 150 countries now rely on it for IT security and Sophos says the market is worth in the region of £40bn, and growing quickly.

It is the only company to offer a high standard of both network and end user protection. This means customers benefit from a joined up service under a centralised system.

Contracts run for up to five years, retention rates are impressive and last year Sophos generated an average of 29% more business from contracts up for renewal.

At present, the company is focused on investing in this opportunity rather than paying dividends, meaning the prospective yield is just 0.8%.

With impressive growth, Sophos's potential hasn't gone unnoticed by the market though.

The shares have enjoyed a strong run recently, and trade on a premium valuation of 85 times expected earnings. We’re not put off by the high rating, but it certainly adds a layer of risk. If the company fails to deliver on the market’s high expectations, the share price could suffer.

Part of the reason the rating is so high is that accounting convention means Sophos's near-term earnings look artificially low. The costs of winning a contract are accounted for up-front, but the revenues are spread over the life of the deal. For example, the group generated $133m of free cash flow last year, compared to adjusted profits of $38m.

We often look at a company and say profits look great, but where is the cash? With Sophos, in the short-term at least, it's the other way round. Given the choice, this is how we'd like it. After all, it's not without justification they say cash is king.

Number of customers since listing in 2015

Source: Sophos 2017 Annual report

Sophos Group price and charts

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Sophos Group
  • Protects small and medium sized businesses against cyber hacks
  • Market worth £40bn and growing quickly
  • Over 100m users in 150 countries

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Investment idea #5

Burberry Group - a new strategy to deliver shareholder returns

  • New CEO focusing on the top end of the market
  • Well placed to benefit from increasing affluence in Far East
  • Ability to return capital to shareholders with buybacks and dividends

Burberry is already a well-established luxury name but new CEO Marco Gobbetti has plans to reposition the group into what he calls the 'most rewarding, enduring segment of the market' - the very top end. The attractions of this strategy are clear.

Top-end customers are usually either fabulously wealthy or determinedly aspirational. With ownership of the product often taking priority over the price, high-end fashion can mean even higher margins.

Nothing comes free though. Elevating the brand to the next level requires sharpening the premium image of its own stores and taking the brand out of several 'non-luxury' outlets.

The costs of the refurb and withdrawal from wholesale agreements means profit and revenue have been sacrificed in the short term. Both should accelerate from 2021, but revising down near-term growth forecasts didn't go down too well with everyone.

Nonetheless, we've never thought chasing short-term approval should be prioritised over long-term returns.

The new strategy should benefit from plenty of long-term tailwinds. The group is well-placed to profit from increasing affluence in the Far East, and with over £800m of year-end net cash on the balance sheet, this gives it a wealth of options for expansion as and when the time is right.

For now, this cash pile should give the group the ability to keep returning cash to shareholders through a dashing combination of buybacks and dividends. Burberry has a £300m buyback programme in place and the prospective yield is 2.3% (variable and not a reliable indicator of future income).

All in all, we like the direction Gobbetti wants to take Burberry in, and applaud his willingness to take tough decisions in order to get the group on what he sees as the right track. Step one will be to deliver smooth progress in the transformation.

Regional mix of Burberry sales

Americas

£681m

Owned stores: 74

Concession stores: 8

EMEIA

£991m

Owned stores: 73

Concession stores: 57

Asia Pacific

£1,069m

Owned stores: 62

Concession stores: 135

Source: Burberry 2016/17 Annual Report

Burberry Group price and charts

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Burberry Group
  • New CEO focusing on the top end of the market
  • Well placed to benefit from increasing affluence in Far East
  • Ability to return capital to shareholders with buybacks and dividends

See price and charts

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. Investments rise and fall in value so investors could make a loss. Unless otherwise stated, information is correct as at 30th November 2017.

These articles are 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. These articles have 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.