Five cheap stocks resilient to Brexit
4th July 2016 14:19
by Harriet Mann from interactive investor
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The one thing we do know about this post-Brexit world is that we have no idea what is around the corner. Whether it's the resignation of UKIP leader Nigel Farage or chancellor George Osborne's pledge to cut corporation tax, the stream of news is fuelling market volatility.
But turbulent markets can create opportunities for quality stocks that are temporarily unloved. Here, and after consulting its 90-strong research team, broker Berenberg has pulled together the five UK stocks it believes have resilience not yet acknowledged by the market.
In a bid to plug the flow of business investment leaving the UK, chancellor Osborne has pledged to cut corporation tax from 20% to less than 15%. This would give the UK the lowest corporation tax of any major economy and should encourage businesses to keep investing here, although Europe would certainly see it as the beginning of the divorce.
It's been 11 days since the UK voted to leave the European Union (EU) and, while the FTSE 100's international exposure has underpinned a spectacular recovery to nearly 4% above pre-referendum levels, the more domestically-focussed FTSE 250 is still trading 6% lower.
Benefitting from higher commodity prices, mining stocks held the FTSE 100 steady Monday. The same was true on the mid-cap index, but the increase at , and still wasn't enough to lift the 250 into the black.
The market was quick in identifying winners after the referendum, and even after their recent outperformance Berenberg thinks that , , , , (the old Reed Elsevier) and are still worth buying.
Below are the five UK stocks Berenberg reckons will be resilient to Brexit volatility.
Ashtead
'Buy', Target price (TP) upgrade to 1,200p
Equipment rental company generates 92% of operating profit from its Sunbelt brand in the US, so it's protected from domestic pressures. Earnings should get a boost from the weaker pound anyway, with foreign exchange tailwinds adding around 6% and 8% to earnings this year and next; this will be slightly offset by weakness in the UK business. A meaty order book underpins future operating performance.
Ashtead has America's economic strength to thank for its impressive growth over the last five years, with the US division driving a revenue compound annual growth rate of 22% - it's expected to keep growing fast. Calming of capital expenditure outflows should also propel a step-up in free-cash flow generation - around £300 million is pencilled in for 2017.
With earnings forecasts upgraded by 5% for 2017 and 2018, Berenberg has upgraded its target price to 1,200p. The stock trades on 9.6 times 2017 earnings, a 25% discount to peers.
Diageo
'Buy', TP 2,350p
Although the drinks giant reports in sterling, only 10% of group sales come from its UK division. has a diverse geographical exposure, with a leading position in the most profitable spirit market - the US - and a majority control of Indian company United Spirits.
The weak pound should provide a transactional benefit to earnings and margins for now. Of course, there are risks - namely if leaders fail to negotiate a tariff-free trade zone. But Diageo owns the largest proportion of the top 50 global spirit brands.
Signs of early improvement in the US and Indian markets should be reflected in this month's full year results. Berenberg reckons the tide is about to turn after two years of de-stocking and poor financials, but investors haven't yet factored this into its valuations.
"The market has already rewarded Diageo's favourable foreign exchange (FX) exposure, but we think the next numbers should show an improvement in trading, allowing it to re-rate towards spirits peers," says the broker.
Dignity
'Buy', TP 2,825p
A funeral services and crematorium owner, demand for services isn't cyclical as it's driven by the UK's mortality rates. In the last downturn, for example, earnings grew at a 12% compound annual growth rate (CAGR) from 2007-2010 thanks to its strong pricing power. It outperformed the mid-cap FTSE 250 index by 35%. With its services purely UK-focussed, Chinese imports explain its small FX exposure.
The high 7% mortality rate seen in 2015 should normalise in 2016, leaving profits flat on the year. Instead of viewing stagnating growth, investors should focus on the 14% CAGR in earnings achieved from 2014-2016.
"With strong pricing power, steady, non-cyclical demand and high margins we believe the business offers investors steadily growing profits with scope for cash returns," explains Berenberg.
"Furthermore, with the company driving growth through Mergers & Acquisitions (M&A), by buying both funeral services sites and crematoria, we believe the business can drive upgrades to earnings through the cycle."
Johnson Matthey
'Buy', TP 3,250p
Amid concerns that catalytic convertor colossus reduced diesel market exposure will hit profitability, the stock has de-rated from 18 times to 15 times forward earnings. This is overdone, reckons Berenberg. Not only should its battery business help offset these falls, but upside to platinum group metals prices could help earnings.
Most of its sales are generated overseas so currency depreciation should support cash profit in 2017.
"JMAT trades on a 12-month forward price/earnings (PE) [multiple] of just under 15x, a discount to (19x) and the UK chemicals sector (c16x). This is despite the fact that JMAT's forecast three-year earnings per share (EPS) CAGR growth is higher than both (7.2% versus 6.1% and 2.8% respectively).
"While focused on capital expenditure-driven growth, JMAT's net debt/earnings before interest, tax, depreciation and amortisation of 1.0x could also enable it to pay special dividends, taking yields to over 9% at current prices."
Prudential
'Buy', TP 1,783p
" is a secular growth story that is exposed to the two largest socio-demographic trends globally - the ageing of the western world and the emerging middle-class across Asia. Whether the UK leaves the EU is but a small sideshow in this context," explains Berenberg.
A mature business, its UK division should not be hit hard by any short-term weakness as it has little exposure - save the M&G fund management division. With 40% of its operational earnings denominated in dollars and 30% of from dollar-tracking Asian currencies, the fall in sterling should provide a nice tailwind.
The noise around the solvency position of Prudential is "nonsensical" to Berenberg and any of its other headwinds are well discounted in the valuation. Trading on nearly 11 times forward earnings, the analysts reckon the shares are worth 1,783p each.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.