The number of foreign companies launching takeover bids for UK firms this year represents a “ringing endorsement” of the value to be found in the domestic market, according to David Smith, manager of the Henderson High Income Trust.
Data from FE Analytics shows the FTSE All Share’s return of 17.08 per cent over the past three years is less than half the gains made by the S&P 500, with Brexit-related uncertainty hindering its progress.
Performance of indices over 3yrs
Source: FE Analytics
However, Smith said investors need to put into perspective the overly bearish scenario being priced into the UK market.
“We’re not going back to 2008/2009,” he explained. “The banking sector has been recapitalised and unemployment is still low. Interest rates, while they are moving up are moving up very slowly, so I think there are reasons to be cheerful.
“Yes, Brexit has created uncertainty but I don’t think either the UK or EU will cut off its nose to spite its face. I think there will be compromise, we have got a transitionary deal, so the talk of no Brexit deal come December 2019 is, I think, unlikely.
“On a P/E [price-to-earnings] basis we are below the long-term average and on a yield basis relative to the global market, we are now at a 15-year high, so this is a good opportunity for UK income investors.”
Smith said he is not the only one seeing value in the UK. On Wednesday, the Japanese pharmaceutical company Takeda announced that it plans to bid for Shire, which follows earlier bids this year from International Paper for Smurfit Kappa, Klepierre for Hammerson, Michelin for Fenner, CME for Nex and Comcast for Sky.
“Now if that isn’t a ringing endorsement for how cheap the UK is and how in the longer term things will be better after Brexit, I don’t know what is,” he added.
The manager invests in what he calls “good companies with great capital discipline, available at the right price” – and he said that the current low sentiment towards the UK has created an abundance of these. He gave the example of Whitbread as a company that is being unfairly penalised for being listed in the UK.
“Whitbread owns Costa Coffee, the largest coffee chain in the UK, and Premier Inn, the largest budget hotel chain in the UK – these are very strong brands,” he said.
“It owns freehold property, which I think covers 80 per cent of the market cap, so if trading really deteriorates, you’ve got downside support from that.
“If you look at the value of Accor, which is a branded hotel chain in Europe, it trades on 20x earnings, while Starbucks trades on 25x earnings. If you apply those sorts of multiples to Whitbread, you are looking at 50 quid a share [it is currently at £37], you know, I think there is material upside there.
“But because it is deemed a Brexit risk, I think that creates opportunity and again you have seen that just by an activist shareholder coming on the register.”
FE Alpha Manager Neil Woodford also thinks the market is pricing in an overly bearish scenario for the UK. In a recent article on FE Trustnet, Sheridan Admans, investment manager at The Share Centre, revealed he was increasing his position in the LF Woodford Equity Income fund, as it is ideally placed to take advantage of the low valuations in the UK market.
“If you look at the income yield on the S&P and the MSCI ex UK and then you look at the FTSE All Share, the income yield has been tipping up in the All Share,” he said.
“So I think you are getting some compensation now in a lot of the income ideas in the portfolio and I think I share his view of the world, which is investing in the UK is not as bad as people are saying.”
Smith said it is not just consumer-focused UK stocks that look cheap, but defensive large caps as well. He pointed out that whereas all of the talk 18 months ago was of “expensive defensives” compared with the price of cyclicals, this has now reversed following a period of synchronised growth across the globe.
“Some of those big cap names are now offering some incredibly attractive dividends,” he continued.
“The likes of Imperial Brands, BT, Glaxo and National Grid are all yielding upwards of 6 or 7 per cent in most cases and again I think that creates a huge opportunity for UK income managers.
“A few years ago you could only justify them being cheap relative to bonds, but these things are cheap in absolute terms now and I am using that as an opportunity.
“I have materially increased my weighting in Glaxo, I have been increasing my weighting in Imperial Brands and I have been adding to Severn Trent, a utility that has been unduly affected by the rise in bond yields.”
Data from FE Analytics shows the Henderson High Income Trust has made 21.37 per cent since Smith took charge at the start of 2014, compared with 31.99 per cent from its IT UK Equity & Bond Income sector and 25.28 per cent from its FTSE All Share benchmark.
Performance of trust vs sector and index over manager tenure
Source: FE Analytics
It is yielding 5.49 per cent and has ongoing charges of 0.81 per cent.
The trust is currently trading at a discount of 1.96 per cent to net asset value compared with a discount of 0.49 per cent and a premium of 0.88 per cent from its one- and three-year averages. It is 25 per cent geared.