Murphy, who is co-manager of the £676m Schroder Recovery fund alongside Nick Kirrage, owns both Tesco and Morrisons – which were two of the FTSE 100’s worst performers last year. A longer-term advocate of banks, he also says they will still have a colossal amount of upside over the medium term.
“In 2009 when we went out on the road trying to market the fund, the only questions we got were about the banks because we owned Barclays, Lloyds and RBS and they were significantly out of favour,” he said.
“However, we haven’t had questions about [holding] banks for quite a while which would suggest people are more relaxed with them. Now every question is about food retailers.”
Once a defensive stalwart, the supermarket sector has been very much out of favour for 18 months as a huge shift in shopper habits transformed the food retail industry. This change has seen discounters such as Aldi and Lidl growing rapidly while the likes of Tesco, Sainsbury and Morrisons have to cope with declining market share.
According to FE Analytics, the three supermarkets’ share prices fell about 45 per cent between December 2013 and December 2014 but all have had a rapid uptick since.
Performance of stocks and index since December 2013
Source: FE Analytics
Murphy said: “We bought at a variety of prices this past year. I’d love to say we bought at the bottom but that isn’t the case. We did what we tend to do: go in too early and then average down aggressively to ensure our average price is at a sizeable discount to our belief of fair value.”
The manager says the positons in Tesco and Morrisons have both reached approximately 3.5 per cent and so he will not be adding to it at this stage.
“We’ll only go up to about 5 per cent as a rule of thumb, although there are some positons that have been bigger but it’d have to have an impregnable balance sheet with cash generation prodigious and the upside very significant.”
“This is not the case with Tesco because of its balance sheet.”
The Schroder Recovery fund holds Royal Bank of Scotland at 4.4 per cent of the portfolio, Barclays at 3.8 per cent and Lloyds at 2.95 per cent.
The three stocks have plummeted since their pre-financial crisis highs. While the FTSE All Share is up 51.5 per cent since January 2007, RBS is down 92.8 per cent, Lloyds 64.4 per cent and Barclays 53.2 per cent.
Performance of stocks and index over 8yrs
Source: FE Analytics
Murphy says these falls have clearly bottomed out. He adds that while investors in the stocks from the 2009 trough have seen significant upside, there is still plenty more to come in the next few years.
“Banks remain the cheapest sector in the UK by a sizable margin. Although it is no longer the lightning rod for sentiment that it once was a couple of years ago, it remains deeply out of favour,” Murphy said.
He says there will be time when the banks and the regulatory environment around them starts to normalise, meaning their revenues can go to their bottom line rather than being depleted by the record fines that have hit the sector in the recent past.
“When that happens the profits will step up meaningfully – the stock market has yet to give them the benefit of that. It has taken away some of the extreme stress that was in the share price but it is yet to truly reflect the underlying intrinsic value that these businesses and franchises deserve to have.”
The manager is not alone in his bullish stance on the UK banking sector with Jupiter’s Steve Davies, who co-manages the £1.3bn Jupiter UK Growth fund alongside Ian McVeigh, also believing they could be soon deliver further upside.
“Some UK banks could be in a position to deliver substantial dividend pay-outs to shareholders in the next 12 to 18 months as their ability to generate profits improves and regulatory requirements on capital and leverage are met,” he said.
“It has been a lengthy convalescence, and while there may still be some way to go, the outlook for some of the UK banks worst hit by the financial crisis of 2007-08 now appears much brighter.”
“This is striking at a time when several of them remain lowly valued both by historical standards and in relation to the wider market, making them, in our view, some of the strongest recovery opportunities on the UK stock market.”
He says Barclays and Royal Bank of Scotland trade below their book value and that while there is no guarantee they can recapture their levels at which they used to trade before the financial crisis, current valuations are gripping.
