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Artemis’ Stuart: The single FTSE sector that still offers value

09 February 2015

Artemis’ Derek Stuart says he is more bearish than ever but is becoming very interested in one of the FTSE 100’s worst performing stocks of last year.

By Daniel Lanyon,

Reporter, FE Trustnet

Returns from UK equity markets will be low for several years but value persists in the beleaguered food retailing sector, according to FE Alpha Manager Derek Stuart (pictured).

The bearish sentiment chimes with a growing number of managers expressing bearish outlooks, who argue that valuations are high while external forces such as political risk in Europe and uncertainty in ahead of the UK election are plentiful.

Stuart, who co-manages the £1.2bn Artemis UK Special Situations fund alongside Andy Gray, says he is not expecting high or double-digit returns over the next year or so.

“We are not finding much value in the market … I would love to say that we were going to make 20 per cent but it is just not going to happen at these valuations,” he said.

“We are in an environment where you have no growth and banks aren't lending. I don't think I have been at a point in my career where I have been confronted with more structurally challenged companies than at this point.”

“If you are invested in the equity market today for earnings growth, you're not going to get a great return because there isn't any. China slowing down, deflation in Europe - why would you do it? The key thing is to get that re-rating opportunity. Get that multiple expansion – that is where you are going to get that re-rating opportunity.”

Stuart has managed the fund since it launched in 2000, over which time it has returned 433.64 per cent, vastly outperforming the IA UK All Companies sector average of 82.06 per cent and gain in the FTSE All Share of 91.76 per cent.

Performance of fund, sector and index since March 2000

 

Source: FE Analytics 

The manager’s cautious outlook has prompted him to tentatively scrutinise the food retail sector as it has seen the largest falls over the past year.

Until recently the likes of Tesco, Morrisons and Sainsbury’s had been defensive stalwarts, but major supermarkets have been one of the most out-of-favour sectors for 18 months due to a vast shift in shopper habits. Discounters such as Aldi and Lidl have been growing very rapidly while the big four – which is completed by Asda – have seen their market share come under pressure.

As the graph below shows, Tesco, Morrisons and Sainsbury’s have seen substantial falls in their share prices over this period, but the stocks have also stated to rapidly rebound over the past month or so.

Performance of stocks over 2yrs



Source: FE Analytics 

Stuart says this is the sector the Artemis Special Situations team are spending the most time and work on with an expectation for significant upside over the next 12 to 18 months.

“Food retailers are the most interesting sector for us at the moment. One of the best stages for us is to find companies that have gone from the growth stage of their evolution to their value – or cash generative – stage, a mature stage. It is often a very messy time,” he said.

“Tesco is the most interesting. At the moment, the market is saying this is a business that can't earn a 3-4 per cent margin but it can happen. Back in 2007-8 you had them growing at high single digits. It was ridiculous. Now you have a realisation that returns on the invested capital are minuscule now. They are not making any money on that. They have to close stores.”

“We are quite excited about that because it is the capital discipline coming in. Tesco were spending £4bn on capital expenditure last year, this year they are spending £1bn. It is the mentality that you don't need more stores that is interesting.”  

However, before taking a meaningful position in Tesco, Stuart is still looking for signs of change from the retailer.

“You have a situation where you have two upstarts [Aldi and Lidl] where people will go to get their Nescafe, Heinz beans and Ketchup. It is 100 products or so that if you can get cheap in Aldi and Lidl, why the hell would you pay the money to do that in Tesco?”

“However, you have a realisation in Tesco that this is not a growth sector anymore. It is a sector where if they get a few things right we might be able to make some money on these stocks. If they price match on a core of 100 products, people won’t go to Aldi and Lidl – which they are starting to do for the first time."

“Secondly, managing a business with 90,000 products is just bonkers: how much choice do you want? If they take it down to 60,000 or 50,000 the supply chain management becomes a lot easier.”


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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.