Interactive Investor

Why Shell was kicked out of this top-performing portfolio

13th April 2017 14:33

David Brenchley from interactive investor

With stockmarkets on both sides of the Atlantic still riding high as the second quarter of 2017 rolls on, equities are still the place to be, it seems. Certainly broker Panmure Gordon thinks so. We rounded up its views on Q2 last week, so we won't bore you with all the gory details once again.

In short, say the analysts at Panmure, "the UK economy cannot defy gravity in perpetuity", explaining that "the looming contraction in real wage growth, the historically low savings ratio and dual deficits point to consumers spending beyond their means".

That said, in the short term, Panmure reckons the UK economy can continue to outperform the consensus. This means there is still an investment case for equities, according to Barry Cornes, Panmure's head of research, underpinned by a widespread appetite for yield and an accelerating global economy.

However, in an update to the firm's top-performing Conviction List, its portfolio now reflects "a moderately more cautious stance". Cornes expects enthusiasm for the reflation trade to wane during the coming three months as it runs into the stark reality of political deadlock in the US and geopolitical risk in the Eurozone.

The Conviction List, a basket of 13 stocks - 12 of which are long positions with one short position, on engineering firm Senior - has returned a meaty 275% since inception in 2010. Its benchmark, the UK small companies index, has returned just 212% over that same period.

However, it has found gains harder to come by over the past five quarters, as shown by the bar chart below.

In order to try and turn the tide, Cornes has outlined a number of additions to the portfolio, with five new long positions replacing six of the previous ones. The short position has also been switched from Ted Baker to Senior.

The biggest name on the exit list is oil major Royal Dutch Shell. The high-yielding blue chip was only added to the list at the start of the previous quarter in January, but shares have slipped 5.6% year-to-date and the team now sees better upside in Kazakhstan-focused Nostrum Oil & Gas.

The slump in the price of oil in mid 2014 and onwards saw 50% wiped off Nostrum's market value in just half a year. A recovery in 2015 followed before it plunged yet again down to a low of 203p by mid 2016.

It made a pre-tax loss of $64.5 million (£51.5 million) last year but has once again been on the path to recovery.

Indeed, the oil explorer has been on an apparently unstoppable winning run of late and has risen over 120% since early April 2016; early March 2017 highs of over £5 were levels not seen for almost 18 months.

The completion of its GTU3 gas plant later this year could see production more than double by 2019, says Panmure analyst Colin Smith.

"Prior to the oil price crash, Nostrum was generating around $200 million per annum in net income. We forecast a return to profitability this year with strong multiple support building from next year."

A forecast price/earnings (PE) ratio of 5.8 times for 2018 would make the firm look much cheaper than it does currently, trading on a multiple of 19.6 times. A free cash flow yield approaching 20% in 2018 and reinstatement of a dividend would be plusses, too.

Smith has a 600p target price on the stock, or 25% upside - a level last attained in July 2015. "As production builds and capex falls, Nostrum should turn into a money-making machine, even at lower oil prices than we forecast," he explains.

Other departures from the long list include underperforming miner Gem Diamonds (-19% return), support services company Hogg Robinson (-5%) and loan provider Morses Club (-6%).

Meanwhile, aerospace industry supplier Chemring has re-rated post interim results and produced a 13% share price gain for the portfolio, while biopharmaceutical firm Hutchison China MediTech has seen strong recent outperformance of a huge 41%.

Panmure's most bullish newcomer is construction firm Melrose, a stock that analyst Sanjay Jha reckons can double in value. "Unlike its UK peers, this is a pure management story and our investment case is not reliant on macro events or commodity prices."

The election of Donald Trump and the effect he has had on the US economy is a plus for Melrose, Jha adds, and the stock should formally join the large or mid-cap index in June, which could be another catalyst for outperformance.

Melrose was barely affected by the Brexit vote, falling just 5% overnight, and it has been on a meteoric rise since 24 June last year - up almost 200% from 79p to 232p today. If Jha is correct, movement up to his target price of 355p would represent gains of 350% since the referendum.

A widely respected new finance director and a "huge market opportunity" could see Smart Metering Systems add 50% to its price from 580p currently to 868p, according to Michael Donnelly.

The two other newbies to the portfolio are challenger bank Aldermore (20% upside) and miner Polymetal International (9% upside).

The companies that make up the rest of the list are Avon Rubber, CareTech, Epwin Group, Informa, McBride, St James's Place and Wizz Air.

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.