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Five shares to watch in 2017

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George Salmon

Equity Analyst

My shares to watch in 2017 are a diverse bunch. There is a recovering pharmaceutical giant, two companies with overseas interests capable of delivering dividend growth and two UK-focused businesses, one of which could be set for continued growth if the economy remains resilient, and the other a more defensive option.

Some will be looking to build on a strong 2016, while others are seeking to make up lost ground. Remember past performance isn’t a guide to future returns, and bear in mind all yields quoted are not an indicator of future income.

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Investment idea #1

Experian – deserving of credit

Experian is best known for providing credit scores. But it also turns its data mining expertise to marketing and analytics, with major operations in both North and South America.

Experian has continued to deliver consistent mid-single digit revenue growth. That’s despite competitive pressure in the US and UK consumer businesses, and a prolonged recession in Brazil (which accounts for 88% of Latin American revenues). It has also consistently returned capital to shareholders, having completed over half its $400m full-year 2017 share buyback programme by November.

If we had a complaint, it’s that margins have remained stubbornly flat. Experian should be a highly scalable operation, but increased regulatory costs, amongst other things, have held it back. Fortunately the group has the size and expertise to handle the burden and still invest to defend and grow market share.

The group is rolling out new services in Latin America, where more than 90% of current revenues come from providing credit services to institutions like banks. Initial performance has been strong, and with a consumer offering in the pipeline, the market looks to have plenty of potential.

At 19.4 times expected earnings, Experian trades on a lofty rating, although analysts expect both earnings and dividends to increase in the coming years. The group offers a prospective yield of 2.2%, and has grown the dividend every year since listing in 2006, though naturally there are no guarantees this will continue.

Source: Experian 2016 half-year results

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Investment idea #2

Auto Trader – driving growth

Auto Trader has evolved from a car buyer’s magazine to become the UK’s leading digital automotive marketplace. It connects buyers and sellers, who pay a regular fee to advertise on the site.

In years gone by, buyers had to view cars in person, but now browsing is increasingly done online. 50% of buyers only visit the forecourt to complete the deal. A strong online presence is therefore critical to a dealer’s success, and Auto Trader seems to have cornered the market.

The group says it attracts an audience several times larger than its nearest competitor. This dominance means dealers can’t risk not being on the site, giving Auto Trader the power to raise prices. Average revenue per forecourt per month has increased by 23% over the last two years.

Auto Trader share price, charts and research

Since listing in March 2015, the group has focused on improving service, shedding costs and reducing debt. The prospective yield is just 1.2% at present, but analysts say dividends should be more than 50% higher by 2020.

With a weak pound and economic uncertainty threatening new car sales, the second hand market could pick up the slack. Yet while second hand car sales are more resilient than new, Auto Trader could still be vulnerable should the economy slip. The shares trade on a price to earnings (PE) ratio of 23.7 times expected earnings.

Source: Auto Trader 2016 annual report

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Investment idea #3

RPC Group – the whole package

RPC is one of Europe’s leading manufacturers of rigid plastic packaging – think yoghurt pots, shampoo bottles etc. Glamorous it isn’t, but the group has been able to increase its dividend every year since 1995, though there are no guarantees this impressive record will be maintained.

Its strategy of targeting higher-margin, more resilient consumer goods packaging has helped it grow margins from 4.6% in 2009 to 10% in 2016. That’s despite economic turmoil in its core European markets, where it would be well-placed to benefit from any turnaround.

The plastic packaging industry is fragmented, with RPC commanding just 6% of the European market. In recent years the group has sought to grow by snapping up smaller competitors to supplement its steady organic growth.

RPC has a good record of taking costs out of acquired businesses, not least through increased polymer (raw plastic) buying power. However, a rapid rise in polymer prices would still hit margins. For example, in the five years to 2008, polymer prices rose 80%, with the cost growing from 25% to 33% of group revenue.

RPC Group share price, charts and research

Away from M&A, the group has benefited from the growing popularity of plastic packaging. Compared to alternatives such as metal and glass, it offers cost and weight savings as well as design flexibility. Design matters to RPC, with the group priding itself on offering complex solutions for clients (and charging a premium in return).

The shares have enjoyed a strong run of late, and currently trade on a price to earnings (PE) ratio of 16.2 times expected earnings, with a prospective yield of 2.1%.

Source: Bloomberg 1995 - 2016

Past performance is not a guide to future returns

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Investment idea #4

AstraZeneca – in recovery?

It’s been a tough couple of years at AstraZeneca. Earnings per share has fallen steadily since 2011 as blockbuster drugs have lost patent protection and rivals launched generic alternatives. Astra has responded by cutting operating costs and boosting investment in the drugs pipeline.

This has started to yield results, with new oncology treatments an area of particular strength. Lung cancer drug Tagrisso is growing rapidly, up 33% quarter on quarter in the US, and management expect growth for many years to come. Cardiovascular drug Brilinta is also enjoying rapid growth, with sales expected to peak at around $2bn a year, compared to last year’s $619m. However, analysts still expect overall earnings to fall slightly in 2017, with only minimal growth in 2018. Investors will be focused on what is still to come out of the labs.

Head and neck cancer trials have been resumed after a temporary suspension in October, with initial results expected in the second half of 2017. But it is the Mystic trial which will attract the most attention, with results from the lung cancer trial expected in the first half. Some analysts believe even a partially successful outcome could generate revenues of $7bn a year – although others remain sceptical.

AstraZeneca share price, charts and research

Investors should note that the shares have enjoyed a strong run on the back of a weaker pound, and a recovery in sterling could exert some downward pressure. However, for those willing to back management’s belief in the pipeline, the stock offers a prospective yield of 5.3%. AstraZeneca shares are currently trading on a price to earnings (PE) ratio of 13.9 times expected earnings, slightly below their long-term average.

Source: Thomson Reuters, 13 December 2016

Past performance is not a guide to future returns

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Investment idea #5

Pennon – regulated growth

The last of my shares to watch is FTSE 250 water utility Pennon. The group offers an inflation-linked dividend and has the potential for extra growth outside its core business.

Record low interest rates mean that a high income from cash and bonds has become more difficult to find. With uncertainty over the UK economy, investors have been drawn to the steady earnings utilities typically offer.

However Donald Trump’s victory has raised expectations of interest rate rises in the US, which has pushed up yields in the bond market. In turn, this has led some income investors to drift away from shares and back into bonds. While we cannot be sure what effect the president-elect will have in the longer term, this trend has seen Pennon’s share price fall, increasing its prospective yield to 4.3%.

Nonetheless with interest rates at home set to stay low for some time yet, I feel that Pennon offers an outstanding option for income seeking equity investors. The group plans to increase its payout by 4% plus the rate of RPI each year out to 2020, thereby offering the most generous dividend policy in the sector. However, please remember that dividend income is not guaranteed.

Inflation is expected to jump in 2017, so if Pennon can stick to its targets, investors could get some impressive increases at a time when returns on cash accounts could still be lagging behind RPI.

Pennon share price, charts and research

78% of profit is generated in the regulated water and waste water business, where synergies from the acquisition of Bournemouth Water are progressing well. The prospect of sustained sector-leading returns on regulated equity underpins our confidence in the dividend.

The remainder of profits come from Viridor, the waste management business. Waste is sorted and recycled, with the remainder burned in energy recovery facilities (ERFs). The group expects to generate £100m of profit from ERFs this year, and recently committed to opening its 12th facility, a £252m plant in Avonmouth. The presence of this division brings the potential for faster earnings growth than other utilities, although it does carry extra risk.

Source: Thomson Reuters 13 December 2016

Past performance is not a guide to the future and yields are not a reliable indicator of future income

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.

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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