4th December 2013
Our new expert blogger, Edmund Shing, Global Equity portfolio manager at BCS Asset Management, outlines his approach to investing and suggests three shares that could help investors play the UK’s industrial recovery.
My approach to selecting stocks to invest in takes in several steps. I like to start with an interesting and timely macro or investment theme, for instance here the current recovery in UK industrial activity.
I then look for stocks that are exposed to this investment theme; these can be UK or foreign stocks, and can range in size all the way from FTSE 100 constituents down to small-caps or even occasionally micro-caps.
Thirdly, I prefer to invest in stocks that offer good value in terms of price/earnings, price/book, price/sales or dividend yield ratios, and also that offer good profitability in terms of profit margins or return on equity ratios.
Finally, I look at price momentum for these stocks. I look to invest in stocks that show positive price momentum over at least 1 month, suggesting that the market is starting to recognise the attractive nature of these stocks via rising share prices.
The UK Economy Leads the Way!
Let’s start with the good news: The UK is growing faster than any other major developed economy in Europe! Of course, being a largely consumer-led economy, this has a lot to do with households, and the London & South East housing market in particular. In the lead-up to our annual year-end festive holidays, UK retailers will doubtless see the usual pre-Christmas surge in sales. In particular, the trend towards online present-buying is expected to continue unabashed, helped by the arrival of the “Cyber Monday” promotional events from the US, led by online sales giants such as amazon.com.
Manufacturing is surprisingly strong
However, we should not overlook the fact that manufacturing is enjoying a global renaissance after a long period following the global financial crisis where investment levels remained chronically low. The UK is a prime beneficiary of this industrial renaissance, with the recent UK manufacturing PMI survey (from Markit) defying expectations to hit 58.4, its highest level since early 2011. Indeed, the industrial recovery within these shores far outstrips that seen to date in the Eurozone, which of course includes that global industrial powerhouse, Germany.
Finding UK industrial stocks that should benefit
That said, one issue holding back UK large-cap exporters such as Rolls-Royce is the currency – sterling is reflecting the UK’s economic vigour by strengthening versus its main counterparts, the US dollar, the euro and the Japanese yen. This eats into the competitive position of these global exporters, as the global aerospace industry tends to price aircraft and components in US dollars.
I would instead look beyond the classic British large-cap exporters to mid and small-cap names which have specialist positions in manufacturing, enabling them to compete on quality and even exclusivity rather than price, and allowing them to generate high profit margins as a result of their strong competitive positioning. The three UK manufacturing names below satisfy these criteria, offer reasonable valuations and also show a healthy progression in share price over the year to date:
British Polythene (BPI.L): a leading manufacturer of polythene products for use in a wide variety of end-industries including construction, agriculture and waste management (their website http://www.bpipoly.com/ provides a wealth of detail on their activities). They offer double-digit operating profit margins highlighting their quality and strong market position, but is still valued at only 12 times 2014’s estimated earnings even after a substantial rise in its share price in the year to date.
Fenner (FENR.L): a world leader in polymer technology (see http://www.fenner.com/en/home). Operating margins should approach 12% for this financial year (which ends in August 2014), while again offering a modest 12.7x forward price/earnings ratio (P/E) and an improving share price to boot. At the time of its preliminary results announcement in mid-November, the company pointed to improving customer sentiment both in the US and also Australian mining and also expects year-on-year growth, which is encouraging given the headwind of stronger sterling.
Renold (RNO.L): a manufacturer of transmission and conveyor chains, gearboxes and many other power drive-related products (http://www.renold.com/). This is more of an industrial recovery stock, as it suffered heavily during the 2008-09 financial crisis, seeing its share price slump at the time from a 2007 high of 120p to as low as 13p by early 2009. It has since recovered gradually to 51p today, as profitability has been progressively restored, with operating profit margins forecast to rise well above 5% by the financial year ending March 2015. A forward P/E of 13x again seems very reasonable, given the expectation of rapidly recovering earnings as Renold continues on its recovery track.
I would always urge readers to do their own research, with the company websites typically a treasure trove of information on a company’s activities, as well as giving access to financial reports and company presentations. But the UK’s industrial renaissance looks to give a timely signal to hunt out such mid- and small-cap manufacturing gems.